David Henderson on Fed Chair Bernanke

Posted by PrestoPundit on 01/26/2006


The second thing not to like is Bernanke’s strong fear of deflation. He has made it clear that he favors price stability, which, he has pointed out, “means avoiding both deflation and inflation.” Economists can tell you why inflation is bad: it’s a tax on money and it’s more hidden than most taxes. But one of the economists who studied the issue most carefully, Milton Friedman, concluded that the optimal growth rate of the money supply is one that yields deflation. Why? Friedman argues that the cost to the government of producing paper money is essentially zero and that, therefore, the cost of holding money should be zero so that people will hold the optimal amount of money. But the cost of holding money is simply the interest you give up by holding it. So the way to get the cost of holding money down to zero is to have a zero nominal interest rate. This would happen if we had deflation whose magnitude equaled the real interest rate — that is, deflation of about 2 percent per year. By contrast, Bernanke’s fear of deflation, as far as I can tell, is not based on economic reasoning.

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