Thursday, March 20, 2008
Caroline Baum at Bloomberg notes the important differences between the Federal Reserve and central bankers in Europe - the operative words are deflation and hyperinflation.
Put a gun to a central banker's head, and he'll repeat the mantra that inflation is always and everywhere a monetary phenomenon. Money -- too much of it -- causes inflation; too little, the reverse.Having never experienced anything akin to hyper-inflation in the U.S., save for periods around both the Revolutionary War and Civil War, this is all the more reason to think that hyperinflation is much more possible than many experts currently believe.
Yet when Fed officials talk about inflation, it's as if it were an exogenous event.
That's not the case in Europe. The memory of 1920s hyperinflation is forever etched into the psyche of German central bankers. The recollection of wheelbarrows full of worthless deutsche marks has haunted generations of Bundesbankers and European Central Bankers after them.
That may explain the ECB's reluctance to lower interest rates at a time when economic growth is slowing: Inflation in the euro area is accelerating at a 3.3 percent rate, a 15-year high.
For U.S. central bankers, the great deflation of the 1930s is imprinted in their collective conscience, something to be avoided at all costs.
In early 2003, just as U.S. economic growth was accelerating after a prolonged recovery from the 2001 recession, both then-Fed Chairman Alan Greenspan and then-Fed Governor Bernanke talked about the risks of deflation. The federal funds rate was still at 1 percent in the first half of 2004, even as the economy was booming.
Bernanke returned to the subject of the Great Depression repeatedly during his stint as Fed governor from 2002 to 2005, detailing where the Fed went wrong and what the Fed could have done to ameliorate the problems of the banks (provide liquidity or lower interest rates).
In his book of essays, Bernanke calls the Great Depression the "Holy Grail of macroeconomics."He writes that "the experience of the 1930s continues to influence macroeconomists' beliefs, policy recommendations, and research agendas."