Letting it happen here
In 2001, Ben Bernanke earned the nickname Helicopter Ben, after a talk he gave at the National Economists Club. The title of the talk was “Deflation: Making Sure ‘It’ Doesn't Happen Here,” a reference to the spiral of disinflation, leading to economic stagnation, leading to outright deflation, that gripped Japan for over a decade after the collapse of its real estate and stock bubbles.
Bernanke, then a Federal Reserve governor – now its chairman – argued that this spiral of economic destruction could be prevented in the United States:
Virtually all economists agree that disinflation and deflation are caused by a shortage of dollars in the economy. The majority agree that such deflation is accompanied by a rise in unemployment. If inflation is too many dollars chasing too few goods, then deflation is too few dollars chasing too few goods. As a side effect some of those goods are never caught. No one buys them, their producers lay off workers and unemployment rises.
The U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.
But, Bernake said, we need not let it happen here. The problem is – we are.
The economy is contracting, inflation is falling, wages are stagnant and we are dangerously close to outright deflation. The spiral has come home to America.
Intimidated by inflation hawks, however, Ben Bernanke said, “I have rejected any notion that we are going to try to raise inflation to a super-normal level in order to have effects on the economy.”
That’s true Fed speak, so let me see if I can parse it out for you.
The economy is being dragged down by the spiral of ever lower inflation. As banks and businesses see inflation fall, it only increases their incentive to sit on the cash they have. As I mentioned before, if we reach outright deflation then they can earn a profit simply by stockpiling money in vault. Every year as prices fall the money locked in that vault would become more and more valuable.
However, money locked in a vault does nothing to support economic growth. It does not fund new investments, new workers or new products. Without that base of new investment or new spending, prices fall further, goods are discounted more deeply and the deflation spiral worsens.
We could power out of such a spiral by raising inflation expectations. The Fed could promise that any decline in prices today would be met by an equal rise in prices tomorrow. Any business considering sitting on its cash would know that know that this is a losing proposition. What it gains by taking advantage of disinflation today, it will lose when exposed to re-inflation tomorrow.
Making this plan work, however, requires that the Fed be willing to produce catch-up inflation -- a short period in which inflation would be higher than normal, so as to make up for the current period were inflation is lower than normal.
At a talk this weekend, Bernanke, however, "rejected any notion that we are going to try to raise inflation to a super-normal level in order to have effects on the economy."
That is, he has rejected the idea of catch up inflation. He has rejected using the Fed to power out of the spiral. He has decided to let it happen here.
We can only hope that time will bring back the Bernanke of yore.
Karl Smith is an assistant professor of economics and government at the University of North Carolina and a blogger at ModeledBehavior.com.
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