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Bernankeian Economics

December 3, 2002

It has been interesting to read reactions to the recent speech (Deflation: Making Sure "It" Doesn't Happen Here) given by Fed Governor Ben S. Bernanke before the National Economists Club in Washington, D.C., on November 21, 2002.

Most commentators have focused, with merit, on Bernanke's alarmingly sanguine approach to monetary inflation as a tool to combat evils and achieve all manner of economic good (as discerned, of course, by "policymakers").  Bernanke said:

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. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

However, an appropriate response to this might be: What else is new?  Anyone who follows Monetary Base data knows that Bernanke is simply restating a fact of life with fiat currency.  Reviewing the data, we can see that the Monetary Base has almost tripled since August of 1987, which dates from the beginning of Alan Greenspan's term as Chairman.

The most revealing remarks in Bernanke's speech might be his frequent but subtle references to the Fed as if it is just another branch of the federal government.  This runs counter to the most common historical argument in favor of central banks: that they are public guardians who act out of virtue and altruism, and thus must remain independent (and above) the nastiness of government and politics.

Murray Rothbard begins The Case Against the Fed by rebutting a typical defense of the Federal Reserve Bank against any public effort to unveil even the slightest bit of its secretive operations: "The standard reply of the Fed and its partisans is that any such measures, however marginal, would encroach on the Fed's 'independence from politics,' which is invoked as a kind of self-evident absolute.  The monetary system is highly important, it is claimed, and therefore the Fed must enjoy absolute independence." (p. 5)

He goes on: "It is instructive to examine who the defenders of this alleged principle may be, and the tactics they are using.  Presumably one political agency the Fed particularly wants to be independent from is the U.S. Treasury.  And yet Frank Newman, President Clinton's Under Secretary of the Treasury for Domestic Finance, in rejecting [proposed reform by Cong. Henry Gonzalez], states: 'The Fed is independent and that is one of its underlying concepts.'" (p. 6)

Rothbard even throws in this edict from the ultimate "policymaker" himself: "In subsequent Congressional testimony, Chairman Alan Greenspan elaborated this point.  Politicians, and presumably the public, are eternally tempted to expand the money supply and thereby aggravate (price) inflation…The Fed's lack of accountability, Greenspan added, is a small price to pay to avoid 'putting the conduct of monetary policy under the close influence of politicians subject to short-term election cycle pressures' (New York Times, October 14, 1993)." (pp. 7–8)

After reading several reviews of Bernanke's speech, all of which quoted directly from the text, I had this feeling that something seemed out of context.  I retrieved a full text of the speech and conducted a word search for the use of "government" in the speech.  The first nine hits revealed the following statements (all emphasis added):

"I am confident that the Fed would take whatever means necessary to prevent significant deflation in the United States and, moreover, that the U.S. central bank, in cooperation with other parts of the government as needed, has sufficient policy instruments to ensure that any deflation that might occur would be both mild and brief."

"As I will discuss, a central bank, either alone or in cooperation with other parts of the government, retains considerable power to expand aggregate demand and economic activity even when its accustomed policy rate is at zero."

"In the remainder of my talk, I will first discuss measures for preventing deflation--the preferable option if feasible. I will then turn to policy measures that the Fed and other government authorities can take if prevention efforts fail and deflation appears to be gaining a foothold in the economy."

"Furthermore, the specific responses the Fed would undertake would presumably depend on a number of factors, including its assessment of the whole range of risks to the economy and any complementary policies being undertaken by other parts of the U.S. government."

"Indeed, under a fiat (that is, paper) money system, a government (in practice, the central bank in cooperation with other agencies) should always be able to generate increased nominal spending and inflation, even when the short-term nominal interest rate is at zero."  (My comment: Yikes!  This one is really instructive.)

"But 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."

"By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services."

"We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation."

"Of course, the U.S. government is not going to print money and distribute it willy-nilly (although as we will see later, there are practical policies that approximate this behavior)."

Notice what is implied when the Fed is grouped with "other parts of the US government."  A truly independent institution could not be properly referenced in this way.  I would not refer to my own actions in concert with "other" members of the family next door.  I would simply refer to such actions with "members" of that family.  However, I would certainly refer to my own actions in concert with "other" members of my own family.  The use of language here is subtle but significant, and reveals much about the author's attitudes.

Bernanke portrays an almost familial connection between the Fed and the US government so often that one might conclude it is deliberate and purposeful.  In fact, he fails at any point in the speech to draw any significant distinction between the Fed and the US government.  

One statement bears repeating simply for its unequivocal meaning:  "Indeed, under a fiat (that is, paper) money system, a government (in practice, the central bank in cooperation with other agencies) should always be able to generate increased nominal spending and inflation, even when the short-term nominal interest rate is at zero."

 Note that he considers a government to be, in practice, the central bank.  At least he did not make the mistake of implying that the central bank is, in practice, the government!  That might have touched a nerve or two.

One consistent theme among the reviewers of Bernanke's speech is the belief that this is possibly one of most important speeches on Federal Reserve and monetary policy in the past fifteen years.  It is thought that the purpose was to make unambiguous the Fed's views on deflation.  If so, it might be interesting to consider why the speechwriters appear to have dropped all pretenses regarding the Fed's long cherished independence from government and politics.  

By the way, for those who are curious, after the first nine hits, all of which connect the Fed with the government, the word search hits mostly references to securities, such as US government bonds and foreign government debt.  However, one of the final hits lands on this gem, found in the footnotes to the speech:

"Keynes, however, once semi-seriously proposed, as an anti-deflationary measure, that the government fill bottles with currency and bury them in mine shafts to be dug up by the public."

I know what you're thinking:  That Keynes, what a great "policymaker!"


Michael King teaches finance and economics at the Benedictine College in Atchison, Kansas. mking@benedictine.edu


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