Must read for this thread (yes, the whole thing) to
eliminate ANY confusion
Deflation: Making Sure "It" Doesn't Happen Here
Remarks by Governor Ben S. Bernanke
Before the National Economists Club, Washington, D.C.
November 21, 2002
federalreserve.gov
Here is part of it.
"What has this got to do with monetary policy? Like gold, U.S.
dollars have value only to the extent that they are strictly
limited in supply. 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).8
Normally, money is injected into the economy through asset
purchases by the Federal Reserve. To stimulate aggregate
spending when short-term interest rates have reached zero, the
Fed must expand the scale of its asset purchases or, possibly,
expand the menu of assets that it buys. Alternatively, the Fed
could find other ways of injecting money into the system--for
example, by making low-interest-rate loans to banks or
cooperating with the fiscal authorities. Each method of adding
money to the economy has advantages and drawbacks, both
technical and economic. One important concern in practice is
that calibrating the economic effects of nonstandard means of
injecting money may be difficult, given our relative lack of
experience with such policies. Thus, as I have stressed
already, prevention of deflation remains preferable to having
to cure it. If we do fall into deflation, however, we can take
comfort that the logic of the printing press example must
assert itself, and sufficient injections of money will
ultimately always reverse a deflation.
So what then might the Fed do if its target interest rate, the
overnight federal funds rate, fell to zero? 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.9 There are at least two ways of
bringing down longer-term rates, which are complementary and
could be employed separately or in combination. One approach,
similar to an action taken in the past couple of years by the
Bank of Japan, would be for the Fed to commit to holding the
overnight rate at zero for some specified period. Because long-
term interest rates represent averages of current and expected
future short-term rates, plus a term premium, a commitment to
keep short-term rates at zero for some time--if it were
credible--would induce a decline in longer-term rates. A more
direct method, which I personally prefer, would be for the Fed
to begin announcing explicit ceilings for yields on longer-
maturity Treasury debt (say, bonds maturing within the next
two years). The Fed could enforce these interest-rate ceilings
by committing to make unlimited purchases of securities up to
two years from maturity at prices consistent with the targeted
yields. 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.
Lower rates over the maturity spectrum of public and private
securities should strengthen aggregate demand in the usual
ways and thus help to end deflation. Of course, if operating
in relatively short-dated Treasury debt proved insufficient,
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). |
