The government has a printing press to produce U.S. dollars at essentially no cost

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.

Of course, the U.S. government is not going to print money and distribute it willy-nilly (although as we will see later, there are practical policies that approximate this behavior). Normally, money is injected into the economy through asset purchases by the Federal Reserve. 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. Each method of adding money to the economy has advantages and drawbacks, both technical and economic. One important concern in practice is that calibrating the economic effects of nonstandard means of injecting money may be difficult, given our relative lack of experience with such policies. Thus, as I have stressed already, prevention of deflation remains preferable to having to cure it. 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.

–Ben Bernanke, National Economists Club, Washington, D.C. November 21, 2002

What was Bernanke saying here during this now famous speech? First of all, I reckon Bernanke wishes he had never delivered this speech because of how explicit it is about injecting money and depreciating the value of the dollar – and the degree to which today’s monetary policy can be gauged by this speech. This is what is being dubbed "the helicopter speech." This is the one speech Bernanke has given which makes inflation hawks fear quantitative easing. As to the content of the 2002 speech, it is clear that Bernanke was saying that quantitative easing is essentially money printing – i.e. the Fed can "produce as many U.S. dollars as it wishes at essentially no cost". So let’s get that out of the way first, shall we. You have the Pragmatic Capitalist pointing to Bernanke’s performance last night on 60 Minutes as some sort of proof that QE is not money printing. Yet this is in direct contradiction to Bernanke’s remarks from 2002. What gives? Well, let’s break down the 2002 speech.

Here is the beginning of the part before the section I excerpted above.

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 Bernanke is saying here is that there are no hard deflationary constraints in a fiat currency system like a tether to gold to prevent a central bank from creating electronic dollar credits (what I will call more cowbell from here on) to purchase existing financial assets. If the Fed applies much, much more cowbell, say $8-10 trillion worth, it has to eventually have an inflationary impact. Bernanke’s conclusion, therefore, is that the only real constraints to preventing deflation are self-imposed and, thus, political.

The conclusion that deflation is always reversible under a fiat money system follows from basic economic reasoning. A little parable may prove useful: Today an ounce of gold sells for $300, more or less. Now suppose that a modern alchemist solves his subject’s oldest problem by finding a way to produce unlimited amounts of new gold at essentially no cost. Moreover, his invention is widely publicized and scientifically verified, and he announces his intention to begin massive production of gold within days. What would happen to the price of gold? Presumably, the potentially unlimited supply of cheap gold would cause the market price of gold to plummet. Indeed, if the market for gold is to any degree efficient, the price of gold would collapse immediately after the announcement of the invention, before the alchemist had produced and marketed a single ounce of yellow metal.

Here the Chairman makes explicit what he is saying by giving an analogy. The gold analogy is apt because one cannot create more gold. There is a fixed supply – and only a limited amount more can be mined cost-effectively over time. Fiat money does not have these constraints. If the Fed’s got a fever, the Fed can prescribe as much cowbell as it so chooses. And so we get to the crucial passage.

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.

This is definitely about expectations. What Bernanke is saying is this, "we could create an infinite supply of reserves if we wanted. You must know this. If backed into a corner, we could simply threaten to create this infinite supply. And in so threatening, we would alter inflation expectations dramatically. People would become worried about the value of their money. This would change consumer behaviour and spur immediate consumption in order to prevent loss from currency depreciation."

Bernanke is quite explicit here regarding the potential for currency depreciation that elevated inflation expectations should produce when he says "reduce the value of a dollar".

Bernanke then backs away a bit.

Of course, the U.S. government is not going to print money and distribute it willy-nilly (although as we will see later, there are practical policies that approximate this behavior).

Chairman Bernanke knows the Fed would never risk hyperinflation (nor would politicians allow this). According to this last statement, he does believe the Fed has the tools to create enough inflationary expectations to get more consumption – if the political desire to do so is there. You might ask why the Fed wants inflation when most people (including me) think inflation is bad. That’s a good question I answered in my post Why is deflation bad?

Here’s the kicker now.

Normally, money is injected into the economy through asset purchases by the Federal Reserve. 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.

What Bernanke is saying is this, "we essentially do QE every week during open market operations. We don’t call it QE because it is in the course of controlling the Fed Funds rate, but that’s what it is – QE for short-term money, an asset swap of T-bills for reserves. When we hit zero Fed Funds rates, we don’t need to do short-term QE because rates are at zero percent. Yes, I know we could drive rates below zero in theory, but I’m not going to mention that here. Let Eric Tymoigne write on this one. Instead, what we need to do is consider zero a lower bound and look for other ways to stimulate aggregate demand like effectively giving banks free money or abdicating our independence as a monetary authority in order to take on a quasi-fiscal role by working in concert with the fiscal authorities. They will deficit spend and we will tacitly agree to have the Fed buy the debt on the secondary market via quantitative easing."

These last two points are significant because you can see this is exactly what the Fed has done during this crisis – and these are the points that are most controversial as well. As I see it, Ben Bernanke has been implementing his 2002 speech as Fed Chairman.

Here’s the last bit of this section.

Each method of adding money to the economy has advantages and drawbacks, both technical and economic. One important concern in practice is that calibrating the economic effects of nonstandard means of injecting money may be difficult, given our relative lack of experience with such policies. Thus, as I have stressed already, prevention of deflation remains preferable to having to cure it. 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.

This is mostly boilerplate to end his thinking on the matter. He is saying that these activities are untested so the Fed will need to act judiciously in doing this the right way. Bernanke is by no means saying they will abstain from "nonstandard means of injecting money" into the economy. Notice that Bernanke uses the phrase ‘injecting money’ what I am euphemistically calling ‘more cowbell.’ Bernanke goes on to say the Fed should do this before deflation takes hold.

Translation: it is always preferable to a central bank to print money or create some reasonable facsimile of printing to prevent deflation before its onset than to try and deal with deflation once it has set in.

Quantitative easing: printing money like mad to ward off deflation, 30 Nov 2008

I believe that’s where we are now – right on the verge of debt deflation taking hold via a housing double dip and negative equity. Commodity prices may be rising and passing through in a regressive way into food, energy and clothing. Healthcare and education costs are rising too. But core inflation as measured by the government is declining due to a lack of pricing power. Companies have combated this by trying to prevent cost pressures from feeding through by keeping headcount down. This has effectively meant that lower income households get the bad side of both commodity price inflation and debt/income deflation.

Judging from Bernanke’s previous writing, he seems to think a combination of fiscal and monetary stimulus are what are needed to prevent debt deflation from becoming entrenched in a way that turns cyclical unemployment into structural unemployment. Based on Bernanke’s commentary on 60 Minutes last night, I believe he will continue to prescribe more cowbell, "nonstandard means of injecting money", unless political forces or internal dissent stop him.