I was looking at the official transcript of Ben Bernanke’s last press conference in June and found this exchange interesting:
AKIHIRO OKADA. Mr. Chairman, I am Akihiro Okada with Yomiuri Shimbun, a Japanese newspaper. During the Japanese lost decade in the 1990s, you strongly criticized Japan’s lack of policies. Recently Larry Summers suggested in his column that the U.S. is in the middle of its own lost decade. Based on those points with QE2 ending, what do you think of Japan’s experience and the reality facing the U.S.? Are there any historical lessons that we should be reminded about? Thank you.
CHAIRMAN BERNANKE. Well, I’m a little bit more sympathetic to central bankers now than I was 10 years ago. I think it’s very important to understand that in my comments—both in my comment in the published comment a decade ago as well as in my speech in 2002 about deflation—my main point was that a determined central bank can always do something about deflation. After all, inflation is a monetary phenomenon, a central bank can always create money, and so on. I also argued—and I think it’s well understood that deflation, persistent deflation can be a very debilitating factor in—in growth and employment in an economy. So we acted on that advice here in the United States, as I just described, in August, September of last year. We could infer from, say, TIPS prices—inflation index bond prices—that investors saw something on the order of a one-third chance of outright deflation going forward. So there was a significant risk there. The securities purchases that we did were intended, in part, to end that risk of deflation. And I think it’s widely agreed that we succeeded in ending that deflation risk. I think also that our policies were constructive on the employment side. This, I realize, is a bit more controversial. And we’ve been consistent with that—with that approach. But we did take actions as needed, even though we were at the zero lower bound of interest rates, to address deflation. So that was the thrust of my remarks 10 years ago. And we’ve been consistent with that—with that approach.
So Chairman Bernanke is claiming the “thrust” of his remarks about Japan were on its need to address deflation. And since the Fed did just that with QE2, he believes the Fed under his leadership has been consistent with this approach. Sorry Chairman Bernanke, but I don’t think Governor Bernanke of 2002-2005 would completely agree with that assessment nor do I think it gets to what Mr. Okada was asking. For what Governor Bernanke originally advocated was more than just eliminating deflation. He advocated the adoption of a price level target. Here is Governor Bernanke in a 2003 speech:
For Japan, given the recent history of costly deflation, however, an inflation target may not go far enough. A better strategy for Japanese monetary policy might be a publicly announced, gradually rising price-level target.
What I have in mind is that the Bank of Japan would announce its intention to restore the price level (as measured by some standard index of prices, such as the consumer price index excluding fresh food) to the value it would have reached if, instead of the deflation of the past five years, a moderate inflation of, say, 1 percent per year had occurred… Note that the proposed price-level target is a moving target, equal in the year 2003 to a value approximately 5 percent above the actual price level in 1998 and rising 1 percent per year thereafter.2 Because deflation implies falling prices while the target price-level rises, the failure to end deflation in a given year has the effect of increasing what I have called the price-level gap (Bernanke, 2000). The price-level gap is the difference between the actual price level and the price level that would have obtained if deflation had been avoided and the price stability objective achieved in the first place.
The key difference, then, between Governor Bernanke and Chairman Bernanke is that the former advocated for Japan an explicit price level target that allowed for catch-up inflation whereas Chairman Bernanke at best has advocated for the United States a vague inflation target that does not close the price level gap. That is a big difference. And note what Governor Bernanke says the closing of the price level gap would entail:
A successful effort to eliminate the price-level gap would proceed, roughly, in two stages. During the first stage, the inflation rate would exceed the long-term desired inflation rate, as the price-level gap was eliminated and the effects of previous deflation undone. Call this the reflationary phase of policy. Second, once the price-level target was reached, or nearly so, the objective for policy would become a conventional inflation target or a price-level target that increases over time at the average desired rate of inflation.
In other words, Governor Bernanke believed inflation should be allowed to temporarily rise above normal inflation rates until the previous price level trend was reached. He believed in a “reflation phase.” One reason for doing so would be to reverse unexpected wealth transfers that occurred between creditors and debtors because of the unexpected deflation. A second, related, reason is that it would help restore financial intermediation by improving balance sheets. A third reason is that it would mean nominal spending is recovering as well. Now contrast that with Chairman Bernanke who panders to the common view that any surge in inflation should be avoided; there is no room for nuance on this issue.
Now maybe Chairman Bernanke believes that everything the Fed has done to date has returned the price level to its pre-crisis trend. If so, then Chairman Bernanke can justifiably claim he is being consistent with his former self. Some would challenge such a belief. I would reply that even if the price level has been successfully reflated, at the end of the day it is only indicator of what really matters, nominal GDP (i.e. total current dollar spending) and its return to an appropriate trend level.