In November 2002, Fed Governor Ben Bernanke introduced the concept of Quantitative Easing to the world. In a speech entitled “Deflation: Making Sure It Doesn’t Happen Here”, he explained that the Fed could prevent deflation from taking hold in the United States by creating money and using it to acquire government and agency (i.e. Fannie Mae and Freddie Mac) bonds. He proclaimed that this “unorthodox monetary policy” would be particularly efficacious if carried out in combination with an expansionary fiscal policy.
With this speech, Bernanke reassured the banking industry and the rest of the speculating community of the Fed’s omnipotence. In doing so, he encouraged even more aggressive credit creation and risk-taking. As a result, the credit bubble, which had already grown quite large, became very much larger. When it imploded six years later, Fed Chairman Bernanke, in cooperation with Treasury Secretaries Paulson and Geithner, responded to the crisis using the exact policies Bernanke had described in 2002.
The Fed began printing very large amounts of money and using it to buy very large amounts of government and agency debt. The Treasury began borrowing and spending trillions of dollars, which it was able to finance at very low interest rates thanks to the Fed’s purchases of government debt. This combination of very aggressive fiscal and monetary stimulus prevented a new great depression and the horrific collapse in prices that would have accompanied it.
Therefore, while it should not be forgotten that Bernanke bears much blame for allowing this crisis to occur, it must also be acknowledged that he was correct when he declared the Fed would be able to prevent deflation through the aggressive use of unorthodox monetary policy.
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