Ben Bernanke’s Policies and Monetary Inflation

Federal Reserve Chairman Ben Bernanke has been accused recently of dangerously provoking inflation with his easy money policies, which are aimed at correcting the unemployment side of the Fed’s dual mandate. While much of the criticism has been politically motivated, the issue still bears a second look, with an eye to historical examples of real monetary inflation.

There are basically three main types of inflation: demand, cost, and monetary. Demand inflation occurs when the economy can’t produce goods and services fast enough to keep up with consumers’ wants. Cost inflation appears after supply shocks, such as the oil embargo of the early 1970s, or dramatic rises in wages or benefits. Monetary inflation seems to be the big worry here; it arises when the amount of money in circulation is so large that money itself loses value, and sellers and earners thus want more and more of it to make up for the loss. Needless to say, such a situation could spiral out of control quite quickly, as happened in Germany in 1921-23, but is that a realistic fear for the U.S. in 2012?

Some critics have accused Bernanke’s Fed of ‘printing money’, in its attempts to inject liquidity into the system since the current recession began. What really happened was that the Fed bought more bonds than it sold – a lot more, but that is what Federal Open Market activity does: buying bonds sends money out of the Fed and into the hands of consumers, banks, and other businesses.

Along with lowering interest rates, the outflow is supposed to induce greater spending and thus get the economy going again, which is half of the Fed’s dual mandate. The other half, maintaining price stability, is admittedly at risk while this is going on, but so far the numbers are benign: during Bernanke’s chairmanship the consumer price index has risen by an average of 2.4 percent, well below those of his predecessors Greenspan (3.1 percent) and Volcker (6.3 percent). Further, the Fed has recently introduced its new ‘inflation target’, which is designed to bring the price level down to a 2 percent annual increase should it get higher.

A 2.4 annual increase in prices isn’t on the same planet as real examples of monetary inflation (hyperinflation) during the 20th Century, and their causes were completely different. In 1921 Germany simply ran out of gold, upon which the reichsmark was based. This situation was in turn caused by reparations to the Allies mandated at Versailles, and not solely to an economic recession. Faced with current debts and bills, the German government literally printed paper money to cover them. When prices sharply accelerated, more money was printed; some 167 presses ran day and night to print notes with more and more zeroes in their denominations. By late 1923 notes were issued into the billions of reichsmarks, and it cost a wheelbarrow of those to buy loaves of bread.

Other notable hyperinflation has occurred in Hungary after World War II, Greece (!) during that War and in the 1950s, and in Argentina, to name some. None of these were caused solely by a central bank seeking to mend an economy, but by governments attempting to pay bills and to keep their ‘lights on’. This does matter: except in stagflation (where we are not), price levels are usually not quick to rise during recessions, making it relatively safe to inject liquidity into the economy. Printing money to pay debts is a very different thing.

Bernanke’s critics are for the most part those who disagree with the Fed’s dual mandate of maintaining price stability and full employment. Perhaps a look at history would be helpful in this debate, and also to put our current situation into perspective.

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