Bernanke's Playbook

In the National Football League, a marginal player dreads the request that he report to the coach and bring his playbook. He figures he is going to be cut from the team. The coach makes sure the playbook does not leave with the player.

A coach’s playbook has a series of self-contained plays. Their importance is not based on their sequence in the book. They are implemented by the coach in specific situations. They may not work in any given game. If they don’t, the team loses the game.

Alan Greenspan never had a playbook, as far as we know. His famous Fedspeak was designed, not to conceal the plays from investors, but rather to conceal the fact that he had no playbook.

Ben Bernanke is different from Greenspan. He has a playbook. He has spent his career studying Milton Friedman’s now-dominant 1963 interpretation of the failure of Federal Reserve Policy, 1930—33, in not reversing the Great Depression. The FED did not inflate, Friedman said. This was in contrast to Murray Rothbard’s 1963 interpretation of the same era. He argued that the FED did inflate, 1924—29, which created the boom that busted in 1929. Had Bernanke studied Murray Rothbard’s 1963 book on Federal Reserve policy as the cause of the Great Depression, he might have had a very different career, perhaps teaching in a community college in North Dakota.

He is not fluent in Fedspeak. Who is? So, he has a different strategy. Lay it out in deadly dull Profspeak. Add footnotes. Deliver the speech to the National Economists Club, an association of men and women who have mastered Profspeak. No problem.

But there was a problem. Bernanke stole one of Friedman’s analogies. Friedman did not lecture in Profspeak. He was so confident that he was right, all the time, that he spoke in plain English. He dared anyone to challenge him. Few people did. I did it only once. It was always a high-risk procedure.

The analogy Bernanke stole was the analogy of a helicopter dropping paper money. Bernanke said in his speech that this was a famous analogy. But it was not famous outside of academia. Bernanke’s speech gave it currency (as punster David Gordon would say). Here is what Bernanke said.

Even if households decided not to increase consumption but instead re-balanced their portfolios by using their extra cash to acquire real and financial assets, the resulting increase in asset values would lower the cost of capital and improve the balance sheet positions of potential borrowers. A money-financed tax cut is essentially equivalent to Milton Friedman’s famous “helicopter drop” of money.

Columnists have either never read the speech (likely) or have forgotten the source of the analogy. Helicopter Ben was merely advocating the helicopter designed by Helicopter Milton.

Am I exaggerating? Hardly. Bernanke gave this speech on November 21, 2002. On November 8, he had given a different speech at a conference at the University of Chicago to honor Friedman on his 90th birthday. As always he delivered an academic speech: a long, tedious summary of Friedman’s 1963 book, A Monetary History of the United States, which is most famous for its section on the Great Depression. (Poor Milton. What a birthday present!) Here is what Bernanke — along with the entire guild of academic economists — derived from that book.

. . . the central bank of the world’s economically most important nation in 1929 was essentially leaderless and lacking in expertise. This situation led to decisions, or nondecisions, which might well not have occurred under either better leadership or a more centralized institutional structure. And associated with these decisions, we observe a massive collapse of money, prices, and output.

What was lacking? Leadership! Also, a more centralized institutional structure. Does this sound like Friedman? You bet it does. On central banking, Friedman was a conventional fiat money economist, a defender of the banking cartel. No gold coin standard for him!

Bernanke ended his speech Happy Birthday with this:

Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.

You bet they won’t!

What can you bet? Your economic future.

Ladies and gentlemen, place your bets!


The playbook is buried deep in his November 21 speech, “Deflation: Making Sure ‘It’ Doesn’t Happen Here.” The speech began with a statement of fact.

Since World War II, inflation — the apparently inexorable rise in the prices of goods and services — has been the bane of central bankers.

He then lists the explanations for inflation offered by economists. One of them is accurate: “an ‘inflation bias’ in the policies of central banks.” It was hidden in plain sight.

This is always Bernanke’s strategy: hide the needle of truth in a haystack of academic qualifications, verbal hedging, and footnotes. He is not fluent in Fedspeak. His strategy works just as well.

He states as fact what clearly is not factual.

. . . during the 1980s and 1990s most industrial-country central banks were able to cage, if not entirely tame, the inflation dragon.

The inflation calculator of the Bureau of Labor Statistics indicates that goods costing $1,000 in 1980 would have cost over $2,000 in 1999. The cage was way too large for my taste.

Although a number of factors converged to make this happy outcome possible, an essential element was the heightened understanding by central bankers and, equally as important, by political leaders and the public at large of the very high costs of allowing the economy to stray too far from price stability.

Over the next four years — maybe longer — these words will come to haunt Dr. Bernanke.

Then he moved from a discussion of inflation (rising prices) to deflation (falling prices).

With inflation rates now quite low in the United States, however, some have expressed concern that we may soon face a new problem — the danger of deflation, or falling prices.

This in retrospect is strange. Who was worrying about deflation in 2002? From the day he became Chairman until the day he left office, Greenspan had warned publicly against inflation. Then the FED inflated. Why this shift? Was Bernanke trying to shift the debate to the opposite issue? No. He was heading it off at the pass.

He began with the definition of inflation common to all schools of economic opinion except the Austrian School: rising prices. Inflation is the opposite of deflation. Here is how he defines deflation.

“Deflation is defined as a general decline in prices, with emphasis on the word “general.”

He does not define inflation as a rise in the money supply, with the effect being rising prices. To define it this way would identify the source of rising prices: the central bank and the fractional reserve commercial banking system.

Bernanke then identified unnamed sources. He also pulled off one of the greatest slight-of-tongue routines in academic history.

The sources of deflation are not a mystery. Deflation is in almost all cases a side effect of a collapse of aggregate demand — a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers.

Did you spot it? It’s here: “side effect.” Falling prices are a side effect. A side effect of what? Falling aggregate demand. What causes falling aggregate demand? He never said.

Here is where long, tedious speeches perform public relations miracles. They put listeners to sleep. That is their purpose.

He then moved in near-prophetic fashion to the American economy in late 2008.

However, a deflationary recession may differ in one respect from “normal” recessions in which the inflation rate is at least modestly positive: Deflation of sufficient magnitude may result in the nominal interest rate declining to zero or very close to zero. Once the nominal interest rate is at zero, no further downward adjustment in the rate can occur, since lenders generally will not accept a negative nominal interest rate when it is possible instead to hold cash. At this point, the nominal interest rate is said to have hit the “zero bound.”

It is widely believed today that the FED will reduce the federal funds rate to zero within the next few months — maybe sooner. Ever since October 29, it has been 1%, down from 1.5%. So, what happens when the rate is zero bound? Will banks stop lending to each other overnight?


Then will they stop lending? No. Banks will not stop lending until they stop taking deposits. Every time a bank takes a deposit, it is announcing: “This deposit will be lent at a higher interest rate than we are paying.” Banks are not in the charity business.

The day your local bank stops taking deposits, you should start to worry about the Great Depression 2 we hear so much about. You should start taking currency out of the ATM.

To take what might seem like an extreme example (though in fact it occurred in the United States in the early 1930s), suppose that deflation is proceeding at a clip of 10 percent per year. Then someone who borrows for a year at a nominal interest rate of zero actually faces a 10 percent real cost of funds, as the loan must be repaid in dollars whose purchasing power is 10 percent greater than that of the dollars borrowed originally. In a period of sufficiently severe deflation, the real cost of borrowing becomes prohibitive.

The cost of borrowing became prohibitive. Really? The U.S. government had no trouble in the 1930’s getting investors to lend it money at rates well under 1%. So does today’s U.S. government. No problem!

Will banks lend to private businesses? Maybe not. That is the real problem we face today: the siphoning off of capital by the U.S. government. Economists call this the crowding-out effect. Most of them deny that it exists. Let’s see, if a dollar is invested in T-bills, it is not invested in business. But that’s not crowding out. No, no, no. It’s something else. What, exactly? They never say, just as Bernanke never says what causes falling aggregate demand.

Although deflation and the zero bound on nominal interest rates create a significant problem for those seeking to borrow, they impose an even greater burden on households and firms that had accumulated substantial debt before the onset of the deflation. This burden arises because, even if debtors are able to refinance their existing obligations at low nominal interest rates, with prices falling they must still repay the principal in dollars of increasing (perhaps rapidly increasing) real value.

What? Dollars increasing in real value? What is this? Americans have seen this only once since 1937: in 1955.

The financial distress of debtors can, in turn, increase the fragility of the nation’s financial system — for example, by leading to a rapid increase in the share of bank loans that are delinquent or in default.

This is beginning to sound remarkable prescient. Did Bernanke see what was coming? Did he finally grasp the Austrian School’s monetary theory of the business cycle? After all, the FedFunds rate was 1% when he delivered this speech.

Closer to home, massive financial problems, including defaults, bankruptcies, and bank failures, were endemic in America’s worst encounter with deflation, in the years 1930—33 — a period in which (as I mentioned) the U.S. price level fell about 10 percent per year.

True. This was why, in 1934, the government created the Federal Deposit Insurance Corporation. This is why banks are not allowed to go bankrupt. Bankrupt banks shrink the money supply. Taken-over banks do not.

Because central banks conventionally conduct monetary policy by manipulating the short-term nominal interest rate, some observers have concluded that when that key rate stands at or near zero, the central bank has “run out of ammunition” — that is, it no longer has the power to expand aggregate demand and hence economic activity.

“Run out of ammunition.” Where have I heard that before? There is a familiar ring to it.

It is true that once the policy rate has been driven down to zero, a central bank can no longer use its traditional means of stimulating aggregate demand and thus will be operating in less familiar territory. The central bank’s inability to use its traditional methods may complicate the policymaking process and introduce uncertainty in the size and timing of the economy’s response to policy actions. Hence I agree that the situation is one to be avoided if possible.

We are now almost there. Two more meetings of the Federal Open Market Committee, and we will be there. Then what?

The playbook tells all.


Bernanke’s playbook is governed by Friedman’s prescription: don’t inflate more than 2% to 3% per year unless there is a depression on the horizon, and then inflate without limit until the crisis goes away. Bernanke followed this playbook from his inauguration on Feb. 1, 2006 until the fall of 2008, when events began to look ominously like 1929. He is now using pages from the section on “hail Mary” plays.

However, a principal message of my talk today is that a central bank whose accustomed policy rate has been forced down to zero has most definitely not run out of ammunition. As I will discuss, a central bank, either alone or in cooperation with other parts of the government, retains considerable power to expand aggregate demand and economic activity even when its accustomed policy rate is at zero.

The central bank can take steps to inflate, despite a FedFunds rate of zero.

As I have already emphasized, deflation is generally the result of low and falling aggregate demand. The basic prescription for preventing deflation is therefore straightforward, at least in principle: Use monetary and fiscal policy as needed to support aggregate spending, in a manner as nearly consistent as possible with full utilization of economic resources and low and stable inflation.

This is being done today. The U.S. government has officially increased the debt by $700 billion (plus $150 billion of pork). The FED has increased its balance sheet by a trillion dollars. The government has taken over Fannie Mae and Freddy Mac loans totaling close to $5 trillion. Congress did not vote on this.

There will be plenty of opportunities for the FED to inflate its way out of this. Why must it do this? Because Prof. Irving Fisher said to.

Irving Fisher (1933) was perhaps the first economist to emphasize the potential connections between violent financial crises, which lead to “fire sales” of assets and falling asset prices, with general declines in aggregate demand and the price level. A healthy, well capitalized banking system and smoothly functioning capital markets are an important line of defense against deflationary shocks. The Fed should and does use its regulatory and supervisory powers to ensure that the financial system will remain resilient if financial conditions change rapidly.

Fisher was the first modern macroeconomist. He was the inventor of today’s definitions of inflation and deflation. By 1933, he was bankrupt, having run through his own fortune — he had invented the Rolodex — and his wife’s sister’s fortune. He had announced in September 1929 that the stock market was not going to fall. He was wrong.

Irving Fisher is the patron saint of central bank policy in the same way that John Maynard Keynes is the patron saint of modern deficit fiscal policy. Fisher was wrong in 1911, wrong in 1933, and wrong today. Yet he is the most influential economist of our day . . . still. This is why we are in big trouble.

What is in store for America? Monetary inflation on a scale not seen since World War II.

As I have mentioned, some observers have concluded that when the central bank’s policy rate falls to zero — its practical minimum — monetary policy loses its ability to further stimulate aggregate demand and the economy. At a broad conceptual level, and in my view in practice as well, this conclusion is clearly mistaken. Indeed, under a fiat (that is, paper) money system, a government (in practice, the central bank in cooperation with other agencies) should always be able to generate increased nominal spending and inflation, even when the short-term nominal interest rate is at zero. . . .

What has this got to do with monetary policy? Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

Then Bernanke gave us two of his key plays from his playbook. Nobody paid any attention. They pay attention now.

To stimulate aggregate spending when short-term interest rates have reached zero, the Fed must expand the scale of its asset purchases or, possibly, expand the menu of assets that it buys. Alternatively, the Fed could find other ways of injecting money into the system — for example, by making low-interest-rate loans to banks or cooperating with the fiscal authorities.

I therefore suggest that you take him seriously.

If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation.

He was only halfway through his speech at this point. But you get the idea. He ended with his now-famous words:

A money-financed tax cut is essentially equivalent to Milton Friedman’s famous “helicopter drop” of money.


He ended his speech with these words: Nevertheless, I hope to have persuaded you that the Federal Reserve and other economic policymakers would be far from helpless in the face of deflation, even should the federal funds rate hit its zero bound.

We are now reaching the point of the helicopter drop. If the FED does not reverse its policy of buying bad debt with new money — high-powered money, as Friedman called it — we will get mass inflation before the next Presidential election.

Bernanke told us what he would do. Over the last six months, the FED has done it.

It will do more. Worse.

December 4, 2008

Gary North [send him mail] is the author of Mises on Money. Visit He is also the author of a free 20-volume series, An Economic Commentary on the Bible.

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