Betting that a modern central bank is ever “out of ammo” is a mug’s game. Check out this incredibly interesting episode in monetary economics from the Financial Times:
What happens when a country emerges from deflation? Memories of the conquest of inflation are still fresh, but for examples of the reverse we must go back to the 1930s. Japan was one of the first to reflate successfully, thanks to Korekiyo Takahashi, finance minister from 1931 to 1936. His programme involved taking the country off the gold standard and issuing large amounts of bonds to be bought by the central bank. In today’s terms it combined fiscal stimulus, quantitative easing and currency depreciation.
The effect was dramatic. Under Takahashi, national income rose 60 per cent while consumer prices rose 18 per cent. The debt-to-GDP ratio stabilised while stocks doubled.
According to Ben Bernanke, chairman of the US Federal Reserve, Takahashi “brilliantly saved Japan from the world depression”. But there was no happy ending. At the age of 82 he was assassinated by officers enraged by his “exit strategy” of cutting military spending. Reflation should have been withdrawn but inflation soared under the aegis of irresponsible militarists. The lesson of Takahashi-nomics is that reflation can take hold quickly if policy makers are determined.
1. One wonders whether Bernanke, in his heart, would preferred a far more aggressive and consistent bond-buying program the past four years. If so, did he refrain because he felt the Fed lacked the political capital with Congress to do so? Who knows, maybe if the Fed had pursued such a policy, he would not have been reappointed. But this episode does show just how effective monetary policy can be during financial crisis.
2. Of course, the more severe Bernanke critics will see his praise of the pro-inflation Japanese central banker as evidence the Fed will enable the Obama Democrats to inflate away the massive US federal debt rather than cutting spending.
3. More evidence that when a central bank does engage in aggressive monetary policy, exit-strategy communication is vital.
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