Thursday, October 14, 2010

Bernanke, Japan, and the Possibility of Stagflation

The October 12th issue of the WSJ had an interesting article by Jon Hilsenrath titled "Fed Chief Gets Set to Apply Lessons of Japan's History." This is definitely worth reading as it gives us insight into Bernanke's thinking, based upon what he advised Japan while he was a Princeton professor in the 1990's.

These were the two paragraphs that particularly got my attention:
Mr. Bernanke was particularly troubled by Japan's emerging deflation. He argued that Bank of Japan officials had to aggressively manage the public's expectations, because convincing households and businesses that deflation wouldn't persist would help to spur economic activity.

Mr. Bernanke felt that Japan's central bank needed to make a commitment to get inflation higher and keep policy accommodative until it increased. Among his proposals was a suggestion that the bank publicly adopt an inflation target of 3% to 4%.

Is this where we are today? Fiat currency is a confidence game, but never so much as when a central bank is faced with the threat of deflation.

In one of the stated goals, Bernanke proposed that the Japanese buy long-term government debt to finance tax cuts.

Could this stage of the game mean stagflation for Americans? Could the weak consumer be faced with higher living expenses in the process of being forced to spend, borrow, and invest again? Stagflation might result in even more unwelcome political intervention in the way of new subsidies or even price controls in the future.

And would the U.S. be in any stronger economic position as a result of such policy? Is the timing right? Or is it simply one more attempt at the easiest way out for the policy-makers?

From today's FT:
One economist in Japan assigns a 40 per cent probability to deflation in the US – albeit not for several years. He says that low interest rates have had no impact on the moribund US housing market.

“People expect too much from Ben Bernanke. The excess liquidity from the Fed may lift asset prices. It will increase market volatility. But it is not dealing with the structural problems. The bubble will burst. Bernanke is not the white knight who can save the US from deflation.”

But who among us expected the success of the "green shoots" psychology that's been achieved so far?

My favorite economic terms these days are "patchwork economy" and "disequilibrium".

We monkeys are more than a little off-balance in our dice-rolling.