Ben Bernanke took over at a critical moment for the US economy. He, too, made a serious error, related to Greenspan’s. He was slow to realise that the US housing market, and particularly the sub-prime sector, posed a systemic risk to the financial system and indeed to the whole US and world economies.
But when he realised what was happening and what was at stake, Bernanke took radical action. He presided over dramatic innovations in financial and monetary policy, including the programmes of asset purchases known as quantitative easing (QE).
Indeed, he was so in favour of the policy that his nickname was “helicopter Ben”, reflecting the musings of the high priest of monetarism, Milton Friedman, who had once hypothesised the central bank expanding the money supply by sending a helicopter to fly over cities dropping dollar bills on the bemused population beneath.
This is the sense in which Bernanke’s reputation is still in the melting pot. Keynesian interventionists like me believe that his actions saved the day. I have never believed that QE was a magic bullet but I suspect that in the US it, and the other support programmes, prevented a complete disaster. Bernanke’s unorthodoxy was backed up by his profound and detailed study of the Great Depression in the US and the recent deflationary stagnation in Japan.
His studies convinced him that at almost any cost the Fed must prevent the US slipping into deflation. In the conditions of a heavily indebted economy, he was right.
Because deflation hasn’t happened, people are inclined to think that it was never a serious danger. They are wrong. In my view, it hasn’t happened precisely because of the policy actions undertaken to prevent it.
The opposing policies are there to be witnessed in the eurozone, where the ECB continues to set its face against outright QE, even though the eurozone economy has been extremely depressed. The result is that some member countries are already experiencing falling prices and before long the whole zone could be in the grip of deflation. If that occurred, it would be an interesting demonstration of what could have happened in America. It would not be a pretty sight.
But of course there are some people – including many in Congress – who think that Bernanke has been the economic equivalent of the devil incarnate. They look at the huge injections of money and the commensurate expansion of the Fed’s balance sheet and see inevitable inflationary disaster in the future. They could be right. Just as Greenspan’s reputation underwent a complete about-face when the reality of the crash of 2007-08 dawned, if and when US inflation turns up decisively, so Bernanke’s reputation would take a battering.
I have to say, though, as things stand, I don’t think this is likely. The economic indicators certainly don’t support an imminent surge in inflation.
Moreover, when the time comes, if circumstances require, the Fed can reverse its QE policy by sending the helicopter out equipped with a giant hoover to suck the money up again.
This would amount to reverse QE, or quantitative tightening (QT), effected by selling bonds into the market. And if it decided not to do this, perhaps for fear of causing mayhem in the bond markets, the Fed could freeze the cash on banks’ books by forcing them to hold extra reserve requirements. In short, an upsurge of inflation is by no means inevitable.
I agree with Roger Bootle because Mr Bernanke prevented a destructive deflation from gripping the economy, although it has inevitably experienced many disinflationary forces since 2008.
I also disagree with commentators who say the deflation risk was overstated and that we could operate quite nicely in an environment where the purchasing power of our currencies remained constant. Yes, if it was a virtuous deflation where more goods and services were efficiently produced, and sold more cheaply in greater volume, increasing overall productivity.
However, that was never going to be the result of the crash which we faced in 2008. Without Mr Bernanke’s QE measures the risks would have included far more bankruptcies for businesses, banks and particularly households. This would have resulted in a destructive deflation of lower production, sales and revenues. In other words, the USA and many other countries could have experienced a version of the America’s 1930s depression. Some countries have experienced this but primarily because of earlier problems of governance and a lack of Keynesian intervention after 2008.
What about future inflationary risks?
Well, the USA and many other governments are actively pursuing annual inflation rates of 2% and some will obviously be higher, as we already see before the global economy has regained anything close to a synchronised period of GDP growth expansion. However, inflation is seldom something which is spread evenly throughout all sectors of an economy. For instance, most employees and self-employed workers have experienced little in the way of real salary increases since at least 2007, due to two factors.
1) We have a considerably more open global economy than at any other time in human history. This is generally good because it increases global GDP growth and continues to lift many more people into the middleclass. However, more open economies gradually encourage a narrowing of wage differentials across national borders. Additionally, powerful corporate Autonomies are thriving because of their ability to often manufacture where they can do so most efficiently, and sell their products were they receive the best returns.
2) Perhaps even more importantly, our era of accelerating technological innovation ensures that many blue-collar and increasingly white-collar jobs are being replaced by smart machines. This is now occurring at a faster rate than new jobs for humans can be created. After all, the smart machines do not need periodic breaks, holidays, sick leave, or unions. In fact, machines can work at a consistent level of efficiency for 24 hours a day, if required. Machines can also be upgraded more effectively than humans. Even smart machines have yet to be disruptive, disloyal, lazy or unmotivated. They do not need counselling, salary reviews, bonuses, meals, recreation rooms and image enhancing offices. Machines do not go on strike, perpetrate fraud, or jump to the competition with your best ideas or clients. They work constantly, uncomplainingly, and are never observed wasting time by monitoring social media sites or porn during their work shifts.
Wage inflation, not surprisingly, is a diminishing problem for most employers in developed economies. The main exceptions being in very select areas where numbers are small, such as leading professional athletes, top corporate managers and the best IT personnel. As global GDP growth improves, the main areas of inflation are likely to be in choice land and fashionable property or collectors’ items, as has usually been the case.
Developing economies will generally experience much higher levels of inflation, due to either inefficiencies or because their GDP growth rates and standards of living are increasing rapidly. Food price inflation is regarded as a perennial problem and weather conditions are variable. Fortunately, our ability to produce, preserve and transport foods, with the help of technology, continues to increase.
People have often feared that energy prices would soar. They have, occasionally, but technology is now reducing this risk by prolonging the life of vital fossil fuels. Interestingly, the least polluting fossil fuel, as we know, is natural gas. This was regarded mainly as a minor by-product or even waste to be flared off, a little more than a generation ago. Thanks to technological innovation, our ability to find vast quantities of natural gas - then convert, store and transport it - is in the process of turning it into our most important fossil fuel. ‘New nuclear’ power is now available in less threatening methodologies. Technology has increasingly proven that solar power is by far the most efficiently deployed, cost efficient and environmentally friendly form of renewable energy. Countries now have the capacity to lower energy costs somewhat in real terms.
In conclusion, I think we well see somewhat higher inflation over the medium to longer term. However, I do not think this will be anything like the worst inflationary problems that some of us experienced in the last century, not least when wages appeared to be on an ever upwards escalator.
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