Bernanke Doctrine
Encyclopedia
The Bernanke doctrine refers to measures that the Federal Reserve can use in conducting monetary policy
Monetary policy
Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment...

 to combat deflation. Ben Bernanke
Ben Bernanke
Ben Shalom Bernanke is an American economist, and the current Chairman of the Federal Reserve, the central bank of the United States. During his tenure as Chairman, Bernanke has overseen the response of the Federal Reserve to late-2000s financial crisis....

 is the Chairman of the Board of Governors
Chairman of the Federal Reserve
The Chairman of the Board of Governors of the Federal Reserve System is the head of the central banking system of the United States. Known colloquially as "Chairman of the Fed," or in market circles "Fed Chairman" or "Fed Chief"...

 of the United States Federal Reserve.

Background

Bernanke succeeded Alan Greenspan
Alan Greenspan
Alan Greenspan is an American economist who served as Chairman of the Federal Reserve of the United States from 1987 to 2006. He currently works as a private advisor and provides consulting for firms through his company, Greenspan Associates LLC...

 on February 1, 2006. In 2002, when the word "deflation" began appearing in the business news, Bernanke gave a speech about deflation entitled "Deflation: Making Sure "It" Doesn't Happen Here." In that speech, he assessed the causes and effects of deflation in the modern economy. Bernanke states:


"The sources of deflation are not a mystery. Deflation is in almost all cases a side effect of a collapse of aggregate demand
Aggregate demand
In macroeconomics, aggregate demand is the total demand for final goods and services in the economy at a given time and price level. It is the amount of goods and services in the economy that will be purchased at all possible price levels. This is the demand for the gross domestic product of a...

 – a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers. Likewise, the economic effects of a deflationary episode, for the most part, are similar to those of any other sharp decline in aggregate spending—namely, recession
Recession
In economics, a recession is a business cycle contraction, a general slowdown in economic activity. During recessions, many macroeconomic indicators vary in a similar way...

, rising unemployment, and financial stress."

Bernanke doctrine

Bernanke emphasized that Congress gave the Fed responsibility for preserving price stability (among other objectives), which implies avoiding deflation as well as inflation. He stated that deflation is always reversible under a fiat money
Fiat money
Fiat money is money that has value only because of government regulation or law. The term derives from the Latin fiat, meaning "let it be done", as such money is established by government decree. Where fiat money is used as currency, the term fiat currency is used.Fiat money originated in 11th...

 system. Where currency is under a monopoly of issuance, or where there is a regulated system of issuing currency through banks which are tied to a central bank, the monetary authority has the ability to alter the money supply and thus influence the interest rate (to achieve monetary policy
Monetary policy
Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment...

 goals). Bernanke asserted that the Fed "has sufficient policy instruments to ensure that any deflation that might occur would be both mild and brief" .

To combat deflation, Bernanke provided a prescription for the Federal Reserve to prevent it. He identified seven specific measures that the Fed can use to prevent deflation.

1) Increase the money supply
Money supply
In economics, the money supply or money stock, is the total amount of money available in an economy at a specific time. There are several ways to define "money," but standard measures usually include currency in circulation and demand deposits .Money supply data are recorded and published, usually...

 (M1 and M2).
"The US government has a technology, called a printing press, that allows it to produce as many dollars as it wishes at essentially no cost." "Under a paper-money system, a determined government can always generate higher spending and, hence, positive inflation."


2) Ensure liquidity makes its way into the financial system through a variety of measures.
"The U.S. government is not going to print money and distribute it willy-nilly ..."although there are policies that approximate this behavior."


3) Lower interest rates – all the way down to 0 per cent.
Bernanke observed that people have traditionally thought that, when the funds rate hits zero, the Federal Reserve will have run out of ammunition. However, by imposing yields
Yield (finance)
In finance, the term yield describes the amount in cash that returns to the owners of a security. Normally it does not include the price variations, at the difference of the total return...

 paid by long-term Treasury Bonds,
"a central bank should always be able to generate inflation, even when the short-term nominal interest rate is zero ...[this] more direct method, which I personally prefer, would be for the Fed to announce ceilings for yields on all longer-maturity Treasury debt."


He noted that Fed had successfully engaged in "bond-price pegging" following the Second World War.
4) Control the yield on corporate bonds and other privately issued securities.
Although the Federal Reserve can't legally buy these securities (thereby determining the yields); it can, however, simulate the necessary authority by lending dollars to banks at a fixed term of 0 per cent, taking back from the banks corporate bonds as collateral
Collateral (finance)
In lending agreements, collateral is a borrower's pledge of specific property to a lender, to secure repayment of a loan.The collateral serves as protection for a lender against a borrower's default - that is, any borrower failing to pay the principal and interest under the terms of a loan obligation...

.
5) Depreciate the U.S. dollar.
Referring to U.S Monetary Policy
Monetary policy
Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment...

 in the 1930s under Franklin Roosevelt, he states that:
"This devaluation and the rapid increase in money supply ... ended the U.S. deflation remarkably quickly."

6) Execute a de facto depreciation
Depreciation
Depreciation refers to two very different but related concepts:# the decrease in value of assets , and# the allocation of the cost of assets to periods in which the assets are used ....

 by buying foreign currencies on a massive scale.
"The Fed has the authority to buy foreign government debt ... [t]his class of assets offers huge scope for Fed operations because the quantity of foreign assets eligible for purchase by the Fed is several times the stock of U.S. government debt
Government debt
Government debt is money owed by a central government. In the US, "government debt" may also refer to the debt of a municipal or local government...

."

7) Buy industries throughout the U.S. economy with "newly created money"
In essence, the Federal Reserve acquires equity stakes in banks and financial institutions. In this "private-asset option," the Treasury could issue trillions in debt and the Fed would acquire it, still using newly created money.
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