Hawk Helicopter

Fed Chairman Bernake is famous for once having given a speech in which he trumpeted the Fed’s ability to combat deflation by creating money – if necessary, by dropping it from a helicopter. The image of Old Ben piloting a chopper, raining dollars on a world fertile for price growth, has stuck in the minds of many inflation hawks and left them with the impression that the Chairman is likely to be relatively soft on inflation. But when we look at his famous statement in context and apply the logic of central banking, it becomes clear that this conventional interpretation is not just incorrect but diametrically opposite to the statement’s true implication.

First we have to recognize that there is a consensus that deflation is bad. It is a matter of dispute just how bad deflation is. But it is fair to say that those who regard deflation as a potentially healthy process are a small minority. To many, deflation conjures up images of the early 1930s, probably the most unpleasant period in the history of capitalism. There is also dispute – and this is where Bernanke’s speech weighs in – about how hard it would be to end a deflation if such a thing were to materialize. The example of Japan suggests a rather pessimistic prognosis, but Bernanke’s speech makes clear that he thinks more effective anti-deflation policies would have succeeded much sooner in Japan.

As a central banker, one is faced constantly with the problem of balancing risks. The biggest risks, I think most would agree, are, on the one side, deflation, and, on the other side, excessive inflation. The problems associated with high inflation are well known. From a central banker’s point of view, it isn’t really the end of the world, because it is generally acknowledged to be curable. The cure, however, is painful and politically difficult, so most central bankers make diligent efforts to provide more than an ounce of prevention. Deflation, on the other hand, is not generally acknowledged to be curable, so some central bankers might regard it as the end of the world. Anyone who does regard deflation as the end of the world is likely to tilt the balance of risks toward inflation.

Bernanke, it should be abundantly clear, is not such a central banker. Bernanke thinks deflation is a solvable problem, just like inflation, and the solution to the deflation problem is a lot less painful than the solution to the inflation problem. Accordingly, Bernanke is not likely to be overly concerned with the risks of pursuing a tight money policy. With his helicopter fueled and ready in case it should be needed, Bernanke’s inclination will be to tilt the balance of risks toward deflation rather than inflation.