Keynesian Deflation Phobia Leads to an Exaggerated View of Balance Sheet Recession Danger

Let's turn to a further source of Keynesian phobia about deflation--balance sheet recessions. In severe cases of deflation phobia, this concern might even extend to the essential rhythm of prices both in a downward and upward direction which would be evident in a well-functioning capitalist economy under conditions of monetary stability (including a fixed anchor to prices in the very long run). Balance sheet recessions were first analysed by Irving Fisher in the context of the Great Depression and have been made much of by some inflation target proponents such as Bernanke (2000). Their trumpeted fear is that the fall in the price level would bring an increase in the real indebtedness of businesses which would hinder their prospects of weathering the recession and moving forward to take advantage of new investment opportunities.

The antidote to this fear is the realization that the recovery of the price level further ahead (beyond the present fall related to recession or start of secular stagnation) will go along with a decline in the real value of the debt (or equivalently there will be a period of substantially negative real interest rates) offsetting the rise in real value during the price fall. . . .

In sum, the harmful balance sheet effects of deflation (rising real indebtedness) only appear where markets fail to put any significant weight on a possible later price level recovery--meaning that substantially negative real interest rates do not emerge.

--Brendan Brown, A Global Monetary Plague: Asset Price Inflation and Federal Reserve Quantitative Easing (Houndmills, UK: Palgrave Macmillan, 2015), Kobo e-book.

Murray Rothbard Makes Much of the Importance of the "Morgan Club" in the Federal Reserve; the Main Counterweight to the Morgan Empire within the Fed Was Paul Warburg of Warburg and Kuhn Loeb

Benjamin Strong stemmed from the Morgan empire, having been the right-hand man of J.P. Morgan during the 1907 financial panic. Morgan later put him at the head of Bankers Trust. Murray Rothbard makes much of the importance of the "Morgan club" as a factor in understanding Federal Reserve policy in its early years. Strong, in taking the position as head of the New York Federal Reserve, had confidently expected that in this role he would be the most powerful official in the new system, although there were some ambiguities about how power would be divided between New York and the board in Washington. At the head of the board was Charles Hamlin, also in the Morgan sphere, as was the Treasury Secretary McAdoo, whose railroad company had been bailed out personally by J.P. Morgan.

Under the initial organization of the Federal Reserve, the Treasury Secretary was an ex-officio member of its board, and McAdoo (now son-in-law of President Wilson) regularly attended its meetings. The main counterweight to the Morgan empire within the Federal Reserve was Paul Warburg, who stemmed from the German banking family of that name and was close to, having married into, the New York banking house of Kuhn Loeb. Warburg has been seen by many historians as "the father of the Fed" in the light of his powerful intellectual and political advocacy of a US central bank, derived from his experience and admiration of banking arrangements in the German Empire and his dismay at the "primitive state" of monetary arrangements which he perceived on arrival in the USA. Strong himself described the Federal Reserve as Warburg's "baby."

--Brendan Brown, A Global Monetary Plague: Asset Price Inflation and Federal Reserve Quantitative Easing (Houndmills, UK: Palgrave Macmillan, 2015), Kobo e-book.

The Obama-Bernanke “Great Monetary Experiment” Was Designed to Drive Up Asset Prices and to Stop Price Deflation

The “Great Monetary Experiment” (GME) launched under the Obama Administration by its chosen Federal Reserve Chief Ben Bernanke was not the first in contemporary history. Indeed, since the Federal Reserve opened its doors, there has been a perpetual rolling out of monetary experiments, albeit the main officials in charge would never have agreed with that description. At most, they would have conceded that circumstances had forced them into monetary innovation, but this had not been their choice.

Those responsible for designing and implementing the GME had no such reticence. As we shall see in this volume, they were ready to gamble US and global prosperity on a set of theoretical propositions and innovatory tools as pioneered under their own chosen brand of neo-Keynesian economics. The justification for doing so was the darkness of the economic landscape in the immediate aftermath of the Great Panic (Autumn 2008) and their promise of an early dawn.

The big new idea in the Great Experiment was to  “drive up asset prices” whilst simultaneously striving to prevent any whiff of price deflation appearing.  “Quantitative Easing” was brandished as the magical tool. In fact, the experiment and the tool were not so new, and any transitory apparent effectiveness depended on a real life replay of the Emperor's New Clothes fable. As the real world theatre performance continued, many practical business decision makers remained anxious.

--Brendan Brown, introduction to A Global Monetary Plague: Asset Price Inflation and Federal Reserve Quantitative Easing (Houndmills, UK: Palgrave Macmillan, 2015), Kobo e-book.