“Obviously” the Fed will Never Run Out of Ammunition

Here’s Ben Bernanke in 1999:

The important question, of course, is whether a determined Bank of Japan would be able to depreciate the yen. I am not aware of any previous historical episode, including the periods of very low interest rates of the 1930s, in which a central bank has been unable to devalue its currency. Be that as it may, there are those who claim that the BOJ is impotent to affect the exchange rate, arguing along the following lines: Since (it is claimed) domestic monetary expansion has been made impossible by the liquidity trap, BOJ intervention in foreign exchange markets would amount, for all practical purposes, to a sterilized intervention. Empirical studies have often found that sterilized interventions cannot create sustained appreciations or depreciations. Therefore the BOJ cannot affect the value of the yen, except perhaps modestly and temporarily.

To rebut this view, one can apply a reductio ad absurdum argument, based on my earlier observation that money issuance must affect prices, else printing money will create infinite purchasing power. Suppose the Bank of Japan prints yen and uses them to acquire foreign assets. If the yen did not depreciate as a result, and if there were no reciprocal demand for Japanese goods or assets (which would drive up domestic prices), what in principle would prevent the BOJ from acquiring infinite quantities of foreign assets, leaving foreigners nothing to hold but idle yen balances? Obviously this will not happen in equilibrium.

Liquidity trap?  Don’t make me laugh.

And here’s Bernanke on Thursday:

“If no action were to be taken by the fiscal authorities, the size of the fiscal cliff is” so large that there’s “absolutely no chance that the Federal Reserve would have any ability whatsoever to offset that effect on the economy,” Bernanke said.


1.  Brainwashed by the FedBorg?

2.  He’s actually saying; “Of course if I were monetary dictator I could keep core inflation at 2%, but there’s no way in hell my colleagues at the Fed will let me do what it takes.”  Thus a white lie.

3.  He’s actually saying “We’d rather you guys take the heat for stimulus, but we’ll do it if we have to.”

4.  A bit of all of the above.

And what are the odds that someone in the Congress would ask him the obvious question?  After all, isn’t the Congress full of Republicans who think Bernanke’s pursuing an inflationary policy?  Do they become born-again post-Keynesians the minute Bernanke walks into the room?  Does the GOP now believe in liquidity traps?  Or is this sort of exercise as silly as trying to decipher what an orangutan is “really thinking” when playing with an iPad?

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About Scott Sumner 492 Articles

Affiliation: Bentley University

Scott Sumner has taught economics at Bentley University for the past 27 years.

He earned a BA in economics at Wisconsin and a PhD at University of Chicago.

Professor Sumner's current research topics include monetary policy targets and the Great Depression. His areas of interest are macroeconomics, monetary theory and policy, and history of economic thought.

Professor Sumner has published articles in the Journal of Political Economy, the Journal of Money, Credit and Banking, and the Bulletin of Economic Research.

Visit: TheMoneyIllusion

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