Od-ys-sey
(noun): a long wandering or voyage
usually marked by many changes of fortune; an intellectual or spiritual
wandering or quest.
After defining deflation, Ben, in his 2002 speech to other
economists, asks and answers the question of the threat of deflation to the US. Ben’s comments follow and are preceded by
bullet points –
·
I believe that the chance of significant
deflation in the United States in the foreseeable future is extremely small,
for two principal reasons. The first is the resilience and structural stability
of the U.S. economy itself.
·
The second bulwark against deflation in the
United States, and the one that will be the focus of my remarks today, is the
Federal Reserve System itself.
·
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.
Next Ben discusses using lower interest rates to fight
deflation:
·
Deflation of sufficient magnitude may result in
the nominal interest rate declining to zero or very close to zero.
·
When the short-term interest rate hits zero, the
central bank can no longer ease policy by lowering its usual interest-rate
target.
·
Hence I agree that the situation is one to be
avoided if possible.
And further expands on avoiding deflation before it happens:
·
… central banks with explicit inflation targets
almost invariably set their target for inflation above zero, generally between
1 and 3 percent per year.
·
The Fed should and does use its regulatory and
supervisory powers to ensure that the financial system will remain resilient if
financial conditions change rapidly.
·
Third, as suggested by a number of studies, when
inflation is already low and the fundamentals of the economy suddenly
deteriorate, the central bank should act more preemptively and more
aggressively than usual in cutting rates
Then Ben says, “Suppose that, despite all precautions,
deflation were to take hold in the U. S. economy and, moreover, that the Fed’s
policy instrument – the federal funds rate – were to fall to zero. What then?"
When the short-term interest rate hits zero, the central bank can no
longer ease policy by lowering its usual interest-rate target. Well, Ben has some more ideas; a lot more
ideas –
·
…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.
·
One relatively straightforward extension of
current procedures would be to try to stimulate spending by lowering rates
further out along the Treasury term structure--that is, rates on government
bonds of longer maturities.
·
If this program were successful, not only would
yields on medium-term Treasury securities fall, but (because of links operating
through expectations of future interest rates) yields on longer-term public and
private debt (such as mortgages) would likely fall as well.
·
…. the Fed could also attempt to cap yields of
Treasury securities at still longer maturities, say three to six years. Yet
another option would be for the Fed to use its existing authority to operate in
the markets for agency debt (for example, mortgage-backed securities issued by
Ginnie Mae, the Government National Mortgage Association).
·
If lowering yields on longer-dated Treasury
securities proved insufficient to restart spending, however, the Fed might next
consider attempting to influence directly the yields on privately issued
securities.
·
For example, the Fed might make 90-day or
180-day zero-interest loans to banks, taking corporate commercial paper of the
same maturity as collateral.
·
For example, the Fed has the authority to buy
foreign government debt, as well as domestic government debt. Potentially, this
class of assets offers huge scope for Fed operations, as the quantity of
foreign assets eligible for purchase by the Fed is several times the stock of
U.S. government debt.
Wow, Ben sure has a lot of things in his carry bag for this
odyssey of his. But, remember this was
ten years ago and Ben may have been thinking – I’d better not scare these guys
too much, at least not yet, so Ben moonwalks backward, just a bit:
·
I need to tread carefully here. Because the
economy is a complex and interconnected system, Fed purchases of the
liabilities of foreign governments have the potential to affect a number of
financial markets, including the market for foreign exchange.
·
I want to be absolutely clear that I am today
neither forecasting nor recommending any attempt by U.S. policymakers to target
the international value of the dollar.
·
Each of the policy options I have discussed so
far involves the Fed's acting on its own.
In practice, the effectiveness of anti-deflation policy could be
significantly enhanced by cooperation between the monetary and fiscal
authorities. A broad-based tax cut, for example…
Then Ben departs from his script – remember he is on the
board of the fed; not in the congress but he plants the seed for the congress to
do their part when he embarques on his odyssey –
·
Of
course, in lieu of tax cuts or increases in transfers the government could
increase spending on current goods and services or even acquire existing real
or financial assets. If the Treasury issued debt to purchase private assets and
the Fed then purchased an equal amount of Treasury debt with newly created
money, the whole operation would be the economic equivalent of direct
open-market operations in private assets.
So Ben was ready to fight
deflation in 2002 – why would that be? And why is Ben already so far down the road on
deflation fighting? In our next chapter,
we will look at just what he has done on this odyssey of his and we will start
to ask some questions using facts and Ben’s own words.
