EconLog

Deflation in the U.S.?, 2002-11-24

Federal Reserve Board Governor Ben Bernanke makes the case that deflation will not happen in the United States.

I believe that the chance of significant deflation in the United States in the foreseeable future is extremely small, for two principal reasons. The first is the resilience and structural stability of the U.S. economy itself. Over the years, the U.S. economy has shown a remarkable ability to absorb shocks of all kinds, to recover, and to continue to grow. Flexible and efficient markets for labor and capital, an entrepreneurial tradition, and a general willingness to tolerate and even embrace technological and economic change all contribute to this resiliency. A particularly important protective factor in the current environment is the strength of our financial system: Despite the adverse shocks of the past year, our banking system remains healthy and well-regulated, and firm and household balance sheets are for the most part in good shape...

The second bulwark against deflation in the United States, and the one that will be the focus of my remarks today, is the Federal Reserve System itself.

Bernanke points out that if deflation brought short-term interest rates to zero, the Fed could shift its attention from the Federal Funds rate to, say, the two-year Treasury note. Alternatively, the Fed could try to restore inflation by intervening in foreign exchange markets to reduce the value of the dollar.

Discussion Question. Bernanke blames Japan's deflationary experience on "political gridlock." Why is he confident that the United States would not experience similar gridlock?