In December 1999, Ben Bernanke wrote an essay that discusses the mistakes made in Japanese monetary policy that led to an asset bubble, an asset price crash and then 20 years of deflation and anemic growth. The essay is important, because it goes deep into the thinkings of Bernanke and how he wants to solve the problems now faced by the US economy.
http://www.princeton.edu/~pkrugman/bernanke_paralysis.pdfAccording to Bernanke, Japan made a series of “important monetary policy mistakes” –
1) The failure to tighten policy during 1987-89, despite evidence of growing inflationary pressures, a failure that contributed to the development of the “bubble economy”
2) The apparent attempt to “prick” the stock market bubble in 1989-91, which helped to induce an asset-price crash
3) The failure to ease adequately during the 1991-94 period, as asset prices, the banking system, and the economy declined precipitously.
“(I)f the Japanese monetary policy after 1985 had focused on stabilizing aggregate demand and inflation, rather than being distracted by the exchange rate or asset prices, the results would have been much better.”
That the key sentence to Bernanke. He is about “Aggregate Demand”. It is all about inflating away debt.
There are many scary parallels between what occurred in Japan 20 years ago and what has been going on in the US since 2008 –
There has been a crash in Asset Prices (namely Real Estate)
Banks are not lending, because their balance sheets are stuffed with defaulting debts
The Fed has dropped the Fed Funds Rate to basically zero
There is Deflation in a number of areas of the economy
Demand is flat and GDP is flat or down
Money Supply growth is weak, as Banks sit on massive piles of cash
Since the early 1980’s, the US has been able to drive growth by lowing Interest Rates and buying on Credit. Consumer Credit has been contracting since 2008 and Interest Rates have very little room left to fall. Rising Credit is essential to keeping the economy growing and falling Interest Rates are required to drive Asset Prices higher.
We now face a new economic reality and Bernanke has his proposals for how the Government can rescue the economy –
“Commitment to Zero Rate – with and inflation target”First you announce “that the zero rate will be maintained for some time to come.” This has been done already by the Fed. Then you announce that you will print enough money to have achieve some target level of inflation –
“In particular, a target in the 3-4% range for inflation, to be maintained for a number of years, would confirm not only that the BOJ (Bank of Japan) is intent on moving safely away from a deflationary regime, but also that it intends to make up some of the “price-level gap” created by eight years of zero or negative inflation.
Further, setting a quantitative inflation target now would ease the ultimate transition of Japanese monetary policy into a formal inflation-targeting framework—-a framework that would have avoided many of the current troubles, I believe, if it had been in place earlier.”
The Fed is now talking about targeting a 1-2% inflation rate. The goal of this is to get the anticipated inflation built into prices and make up for the lack of growth in Real Estate prices over the past decade.
“Depreciation of the Yen”“I believe that a policy of aggressive depreciation of the yen would by itself probably suffice to get the Japanese economy moving again.”
“(T)he BOJ should attempt to achieve substantial depreciation of the yen, ideally through large open-market sales of yen. Through its effects on import-price inflation (which has been sharply negative in recent years), on the demand for Japanese goods, and on expectations, a significant yen depreciation would go a long way toward jump-starting the reflationary process in Japan.”
“In short, there is a strong presumption that vigorous intervention by the BOJ, together with appropriate announcements to influence market expectations, could drive down the value of the yen significantly. Further, there seems little reason not to try this strategy. The “worst” that could happen would be that the BOJ would greatly increase its holdings of reserve assets.”
“Money-financed transfers”This is how Bernanke got the name “Helicopter Ben” –
“Suppose that the yen depreciation strategy is tried but fails to raise aggregate demand and prices sufficiently, perhaps because at some point Japan’s trading partners do object to further falls in the yen.
An alternative strategy, which does not rely at all on trade diversion, is money-financed transfers to domestic households—-the real-life equivalent of that hoary thought experiment, the “helicopter drop” of newly printed money. I think most economists would agree that a large enough helicopter drop must raise the price level.”
“Surely at some point the public would attempt to convert its increased real wealth into goods and services, spending that would increase aggregate demand and prices. Conversion of the public’s money wealth into other assets would also be beneficial, if it raised the prices of other assets.”
“Money-financed transfers do have a resource cost, which is the inflation tax.” In Bernanke’s mind, Inflation is the goal and not a cost…
“Nonstandard open-market operations”“A number of observers have suggested that the BOJ expand its open market operations to a wider range of assets, such as long-term government bonds or corporate bonds; and indeed, the BOJ has modest plans to purchase commercial paper, corporate bonds, and asset-backed securities under repurchase agreements, or to lend allowing these assets as collateral (Ueda, 1999, p. 3). I am not so sure that this alternative is even needed, given the other options that the BOJ has, but I would like to make a few brief analytical points about them.
In thinking about nonstandard open-market operations, it is useful to separate those that have some fiscal component from those that do not. By a fiscal component I mean some implicit subsidy, such as would arise if the BOJ purchased nonperforming bank loans at face value, for example (this is of course equivalent to a fiscal bailout of the banks, financed by the central bank). This sort of money-financed “gift” to the private sector would expand aggregate demand for the same reasons that any money-financed transfer does.”
Bernanke actually defines the purchase of “nonperforming bank loans” as a “’gift’ to the private sector”.
“A nonstandard open-market operation without a fiscal component, in contrast, is the purchase of some asset by the central bank (long-term government bonds, for example) at fair market value. The object of such purchases would be to raise asset prices, which in turn would stimulate spending”.
Where We Are Now
The US Government has already –
Dropped short-term Interest Rates to effectively zero
Bought worthless bonds at 100% of their original value
Substantially weakened the US Dollar
Handed out $800 billion in “stimulus”
Told us that low rates are here for a “extended period”
Told us that here is a “inflation target”
So they are following Bernanke’s playbook. The Fed has clearly bought into Bernanke’s game and will print as much money as they have to to create Inflation. They will also use Gold as a lever to force China to unpeg with the Dollar.
