US Fed chairman Ben Bernanke seems finally set to have his long prefigured “helicopter drop” of money carried out over the US economy during 2009, according to the latest decisions of the Federal Open Markets Committee (FOMC).

He must surely have the D-word – deflation – on his mind.

Just over five years ago when he gave the now famous speech “Deflation: Making Sure ‘It’ Doesn't Happen Here” before the National Economists Club in Washington DC, Mr Bernanke drew instant public attention to himself – a then plain governor of the Fed – by approvingly describing an anti-deflationary combination of fiscal and monetary strategies as follows:

“In practice, the effectiveness of anti-deflation policy could be significantly enhanced by co-operation between the monetary and fiscal authorities.”

“A broad-based tax cut, for example, accommodated by a program of open-market [central bank] purchases of [Treasury debt] to alleviate any tendency for interest rates to increase, would almost certainly be an effective stimulant to consumption and hence to prices.”

“Even if households decided not to increase consumption but instead re-balanced their portfolios by using their extra cash to acquire real and financial assets, the resulting increase in asset values would lower the cost of capital and improve the balance sheet positions of potential borrowers.”

“A money-financed tax cut is essentially equivalent to Milton Friedman's famous ‘helicopter drop’ of money.”

“Of course, in lieu of tax cuts or increases in transfers the government could increase spending on current goods and services or even acquire existing real or financial assets.”

“If the Treasury issued debt to purchase private assets and the Fed then purchased an equal amount of Treasury debt with newly created money, the whole operation would be the economic equivalent of direct open-market operations in private assets.”

The passage earned Mr Bernanke the nickname of “Helicopter Ben” but few would have imagined back then that he would preside as Federal Reserve chairman over the real thing pretty much executed as he described in 2002.

The latest FOMC announcement of a target range for the influential federal funds rate of zero to 0.25% for overnight lending to commercial banks was also accompanied by a “helicopter drop” of equally important measures that basically amount to printing money and throwing it from out of the sky for people to gather up off the streets.

In its press release announcing the Fedeeral Reserve funds cut, the FOMC went on to say, “The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability.”

“In particular, the committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.

“The focus of the committee's policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve's balance sheet at a high level.

“As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant.

“The committee is also evaluating the potential benefits of purchasing longer-term Treasury securities.

“Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses.

“The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity.” Hiring a fleet of helicopters, perhaps, to deliver all the newly minted money.

Outright bulk purchase of debt securities whether issued by the public sector or the private sector is tantamount to printing money, and underwriting lending to households and small businesses is not that far away from it.

What this tells us is that the Fed – and by extension the US economy – is in dire trouble and there must be fears that a Japanese-style bout of deflation may be looming.

Mr Bernanke conceded the Fed was running out of options on December 1, when, in the gloomily named speech “Federal Reserve Policies in the Financial Crisis” he delivered to the Greater Austin Chamber of Commerce, Austin, Texas, he conceded:

“Regarding interest rate policy, although further reductions from the current federal funds rate target of 1 percent are certainly feasible, at this point the scope for using conventional interest rate policies to support the economy is obviously limited …”

“Although conventional interest rate policy is constrained by the fact that nominal interest rates cannot fall below zero, the second arrow in the Federal Reserve's quiver-– the provision of liquidity – remains effective.”

Liquidity, then, will be provided with a vengeance, and perhaps Mr Bernanke and his colleagues at the Fed, his peers over at the US Treasury, and the politicians on Capitol Hill, will between themselves somehow print enough money to stave off Japanese-style deflationary recession.

One assumes that the tactics to be employed are a bit hit or miss, given that Mr Bernanke did not mention a third or fourth arrow spare in the Fed’s quiver.

The concluding remarks from the “Helicopter Ben” speech – with their famous-last-words tenor – bear renewed consideration:

“Sustained deflation can be highly destructive to a modern economy and should be strongly resisted.”

“Fortunately, for the foreseeable future, the chances of a serious deflation in the US appear remote indeed, in large part because of our economy's underlying strengths but also because of the determination of the Federal Reserve and other US policymakers to act pre-emptively against deflationary pressures.”

“Moreover, as I have discussed today, a variety of policy responses are available should deflation appear to be taking hold.”

“Because some of these alternative policy tools are relatively less familiar, they may raise practical problems of implementation and of calibration of their likely economic effects.”

“For this reason, as I have emphasized, prevention of deflation is preferable to cure.”

“Nevertheless, I hope to have persuaded you that the Federal Reserve and other economic policymakers would be far from helpless in the face of deflation, even should the federal funds rate hit its zero bound.”

Well, Helicopter Ben, the fed funds rate has hit zero bound, deflation may be on the way, and we had all better hope that the flight of the Fed’s second and last arrow left is sufficiently well implemented and calibrated to pierce squarely the bull’s eye of its target.
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www.federalreserve.gov/BOARDDOCS/SPEECHES/2002/20021121/default.htm