The Fed chief is needed to slay the dragon of deflation. But Bernanke must be careful.
Where's a good deflation-fighter when you need one? US consumer prices fell in October at the steepest rate since 1938. If that starts a self-reinforcing downward spiral in prices, Barack Obama will need Federal Reserve chief Ben Bernanke more than ever. The former Princeton scholar is an expert on deflation, a pernicious destroyer of wealth.
In a famous speech before he became the nation's central banker, Mr. Bernanke said "sustained deflation can be highly destructive'' and it "should be strongly resisted."
His wise counsel was based on his studies of the Great Depression and of post-bubble Japan in the 1990s, times when consumers and businesses were sucked into a rare mental contagion in which they delayed purchases to see if prices would fall further.
Breaking such a negative pattern, or ending a phenomenon that feeds on itself, can take years. A drop in prices may sound good – who doesn't welcome gasoline at less than $2 a gallon or affordable home prices? But when this anti-inflation becomes rampant, people who are paying off their debt in effect pay more in value over time. Spending dries up. The economy contracts.
Avoiding runaway deflation is why central banks tolerate a low level of inflation – it keeps the bigger beast at bay. For most of this year, the US and many other nations had high inflation, mainly because of rising prices for oil and food. So it was a shock that US consumer prices – excluding food and energy – actually fell in October, the first drop since 1982. A sudden fear of deflation helped knock down the stock market.