Now that Ben Bernanke has handed over the keys of the Federal Reserve, there are all sorts of theoretical arguments, pro and con, concerning his bold quantitative easing (QE) programs, in which the Fed massively expanded its balance sheet:
Many critics, including me, have worried that this will disrupt the proper functioning of credit markets, and threatens to severely debase the US dollar. (Obviously our warnings on the latter point are either totally wrong, or have yet to be fulfilled.)
The defenders of Bernanke have argued that he spared the US (and indeed the world) from a second Great Depression. Moreover, they claim that the Fed will simply let its balance sheet unwind as the economy returns to normal. Bernanke himself discussed several “exit options” when he was still at the helm (which I criticized at the time).
One of the odd points that people raise in Bernanke’s defense is the case of Japan. They explain that Japan implemented a comparable policy, and hey, they didn’t wreck the yen in the process. So why don’t the critics learn their history and cut Bernanke some slack?
Well, hang on a second. Here is a chart (source) showing the relationship between the Japanese central bank’s “monetary base” and price inflation, both expressed as indices of the level:
So yes, it’s true that the Bank of Japan had a rapid expansion of its balance sheet (with the monetary base serving as a proxy), especially in the early 2000s, and yet the official consumer price index is actually lower now than it was in the mid-1990s. (This site shows the annual CPI rates in Japan, many of which were lower than negative 1% during this interval.) I have two responses:
(1) Look at what the Japanese central bankers had to do, to contain the public’s expectations about price inflation. When their CPI stopped (gently) falling and began rising, in the mid-2000s, the central bank drastically reduced its monetary base–that’s the red line falling off a cliff. So really it seems the lesson from Japan is, “Sure you can get away with a rapid expansion of the monetary base without wrecking your currency, so long as you crash the financial sector whenever price inflation begins rising.” I don’t think any of the gold-bugs and other critics of QE denied this; that was part of their warning.
(2) Japan has not at all been successful with its strategy: It is a poster child of an economy stuck in a rut for decades, and counting. The Nikkei 225 (the major Japanese stock exchange) in 2009 was down more than 80% from its peak twenty years earlier. (Yes I wrote that correctly.) So at best, the defenders of Bernanke can say, “Hey, for all you know, we can keep our economy in the gutter for another 20 years without price inflation getting out of hand. You guys are such hypochondriacs!”
In closing, let me point out that we do have historical examples of central banks ruining their economies/currencies through massive expansions of their balance sheets (Weimar Germany, Zimbabwe, etc.). To my knowledge, this has never actually worked anywhere in history. Can anyone point to a successful example?