There is a constant comparison between the United States today and Japan post their 1990 asset bubble. In fact, you will often find a comparison between the US stock market pattern and that of the Nikkei. The reality is that nothing could ever be that simple. In my opinion, there are a few large differences between the US situation and that of Japan, but the one that tops my list is the difference in inflation and the aggressiveness of our central bank versus that of Japan’s. The easiest way to visualize that difference is to look at the reported CPI numbers from the two countries:
Short period of deflation during the crisis, but rapid recovery in inflation for the United States
With today’s reported US CPI coming in at 3.5%, this story has not changed. Ben Bernanke realizes that in a contracting economy, after over-expansion, the most destructive force to add to the mix is a period of deflation and its negative feedback loop – which has been coined the “liquidity trap”. Below, I will reiterate a section from an August 2010 post when inflation was running at just over 1%:
SurlyTrader, August 2010 “The Battle Between (In/De)Flationists“:
In Ben Bernanke’s 1999 paper titled “Japanese Monetary Policy: A Case of Self-Induced Paralysis?”, Ben outlines a set of monetary actions for the Japanese. In the introduction, Ben outlines the reasons for the Japanese scenario, all of which sound eerily similar to our own dilemma:
He follows be going into detail regarding Japan’s deflationary environment throughout the 1990′s and how that indicated that the Japanese monetary policy was not accommodative enough. He then admits that under current financial systems, as opposed to when countries were under the gold standard: ”inflation or mild deflation is potentially more dangerous in the modern environment than it was… (because) The modern economy makes much heavier use of credit, especially longer-term credit, than the economies of the nineteenth century”.
The rest of the paper discusses Bernanke’s argument for how the Japanese monetary policy can get Japan out of its liquidity trap. In what is probably the most enlightening paragraph within the paper, Ben ruffles his “helicopter” feathers:
The general argument that the monetary authorities can increase aggregate demand and prices, even if the nominal interest rate is zero, is as follows: Money, unlike other forms of government debt, pays zero interest and has infinite maturity. The monetary authorities can issue as much money as they like. Hence, if the price level were truly independent of money issuance, then the monetary authorities could use the money they create to acquire indefinite quantities of goods and assets. This is manifestly impossible in equilibrium. Therefore money issuance must ultimately raise the price level, even if nominal interest rates are bounded at zero. This is an elementary argument, but, as we will see, it is quite corrosive of claims of monetary impotence.
Increase aggregate demand by increasing the money supply and purchasing assets. It is as simple as that. This will also destroy the currency which will fuel the attractiveness of goods in the currency:
Indeed, as I will discuss, I believe that a policy of aggressive depreciation of the yen would by itself probably suffice to get the Japanese economy moving again.
After reading the 10 year old academic paper by Ben, you should realize that he has the resolve and tools to get inflation sparked in the United States. The only wild card is if the Federal Reserve’s power is limited by congress or if Ben Bernanke is removed from office. Both of those outcomes seem unlikely to me. As for whether inflation is good, well that is an argument for another day. The only question I have is why anyone in his/her right mind would want to lock in 10 year treasury yields today at 2.6%? (Edit: Today that number would be 2.01%)
You can read Ben’s full paper at your leisure: Bernanke – Case of Self-Induced Paralysis
