Bernanke's gonna go up in a 'copter
Bernanke is famous for his helicopter drop governance principle. In his speech in 2002, he has interesting viewpoints on deflationary recession.
Deflation is a side-effect of drop in consumer spending, and therefore demand. In response to falling demand, producers have no choice but to reduce prices to ramp-up sales. This deflation of prices eats at profit and operating margins of producers, thereby affecting the unemployment rate, industrial growth, etc.
In response to deflation, a country's financial regulatory authority usually decreases interest rates - to promote spending and to encourage citizens to look for alternative investment areas.
But the concept that was way too cool was - nominal interest rate hitting zero. In an extreme situation, nominal lending rate might hit zero, but it still might be prohibitively expensive for someone to borrow money. This is if deflation is prevalent across the entire economy causing the repayment to be made in dollars that have a purchasing power much higher than what you borrowed. (!!)
Now, according to conventional wisdom, once nominal interest rate hits zero, there is further scope for the regulatory to do anything but wring their hands in despair. But Bernanke's thesis goes on to the printing-press theory.
By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services..
Therefore fueling demand. Is this just a theory?
In 2003 and the first quarter of 2004, the Japanese govt. printed several trillion yen. This yen was used by the Bank of Japan to purchase US Govt securities at very low prices. Coupled with tax-cuts by the Bush administration, this led to to savings-glut led surplus turning into a spending deficit within a few years. Increased consumer spending in the US caused Asian economies to accelerate, who in turn used their dollars to settle their deficit with Japan.
The circuit is complete.
Is Bernanke's theory sound? I dont know.. but it sure is cool!!