Shavian monetary policy

Bernanke: US Federal Reserve Chairman Ben Bernanke said in his Jackson Hole speech on Friday he would fight deflation - but he ignored the federal deficit. Even Japan has not experienced sustained deflation, while the US deficit remains at record levels. Bernanke’s diagnosis and treatment of a phantom disease are unlikely to produce faster growth.

Sir Ralph Bloomfield Bonington, the quack in Shaw’s “The Doctor’s Dilemma,” offered a single treatment for all diseases - to “stimulate the phagocytes.” In a similar vein, Bernanke appears to regard the anti-deflationary treatment that the Fed should have applied in 1930-32 as appropriate for all subsequent economic ailments.

The example normally used to illustrate the perils of deflation is contemporary Japan, which has suffered near-recession conditions since its bubble burst in 1990. However, Japan has not actually seen significant long-term deflation but only price stability. Its consumer price index, set at 100 in 2005, stood at 98.9 in 1992 and 99.2 in July 2010.

A more likely major contributor to Japan’s problems is its continual fiscal deficit, boosted by numerous so-called stimulus programs of wasteful spending. These have now pushed the country’s debt to 217 per cent of its GDP, an alarmingly high level.

In Friday’s speech, Bernanke’s only reference to any kind of budget shortfall was to remark that “deficit management is a challenge to many countries.” He could have said much more about the specific US problem, even at the Jackson Hole conference for central bankers. After all, at the 2004 iteration of the conference his predecessor, Alan Greenspan, led off his remarks with a lengthy disquisition on the long term financial burden of Social Security and Medicare - a problem that has worsened since.

Bernanke outlined in detail various possible ways in which the Fed could ease monetary policy further should deflation appear, and ended by reassuring his audience that “the preconditions for a pickup in growth in 2011 remain in place.”

The United States is not, however, currently suffering from deflation. Second-quarter GDP data showed prices rising, while consumer price inflation for the month of July was 0.3 per cent. It is, however, facing a big deficit problem. The Fed chairman’s remedies are for the wrong disease.