The broad scope and open-endednature of the Federal Reserve's third round of quantitative easing(QE3) raises questions about exactly what Fed Chairman Ben Bernankehas in mind. Some insight, remarkably, emerges from a speech hegave in November 2002, when he was simply a Fed board member, tothe National Economists Club in Washington. Taking his cue fromfears at the time about a Japanese-style deflation, Bernanke laidout a path for monetary stimulus in an extreme situation, outliningnon-traditional policy tools that have since become common. Thespeech also took comfort in the relative strengths of the U.S.economy compared with Japan's. Perhaps the dissipation of thoseadvantages contributed to Bernanke's decision to pursue QE3now.

The Fed chairman's 10-year-old talk offers a remarkableforecasting device. It explained how, in an extreme situation,traditional monetary policy tools, even bringing short-terminterest rates down to zero, might not produce enough stimulus, andit listed the “non-traditional” policies the Fed might employ: 1)purchasing longer-dated Treasury, agency, and mortgage-backedsecurities; 2) announcing an intention to keep short rates low foran extended period; and 3) injecting liquidity into financialmarkets by accepting corporate bonds, bank loans, commercial paperand mortgages, among other securities, as collateral for directlending to banks. All these tools made appearances during the2008-09 financial crisis and have lingered in its aftermath. Afourth technique Bernanke mentioned in 2002 involved purchasing thedebt of foreign governments. The Fed has yet to do so, but it mightif there is any further deterioration in Europe.

Behind all of these measures, Bernanke's talk pointed to thegrowth of money and liquidity as the ultimate policy objective toget the economy moving and, in the specific context of his talk, toavoid deflation. He even alluded to running the “printing press”and the “electronic equivalent” to force funds into the economy andfinancial markets. For a while in this more recent period, thatobjective seemed to elude the Fed. Banks failed to lend, and moneygrowth languished. But of late the chairman has gotten hislooked-for responses. Federal Reserve statistics show the narrow M1definition of money has grown at a robust rate of about 11% duringthe last 12 months and accelerated to about a 15.5% annual rate ofadvance over the past three months. The broader M2 definition ofmoney expanded at a strong 6.3% rate during the last 12 months andheld at a 6.5% annual rate of expansion over the last three months.Banks have begun to lend, too. Overall bank lending has expanded atan annual rate of about 3.5% during the past three months, with thecritical commercial and industrial component growing at a 13.7%annual rate.

On this basis, Bernanke might easily haveforegone QE3 or at the very least postponed it. But that same10-year-old speech hints at why he made his bold move anyway. Backin 2002, Bernanke took comfort in important American advantagesthat would protect this economy from Japan's deflation and itsother problems. The American financial system, he noted, was muchbetter capitalized than Japan's, businesses and financialinstitutions had greater confidence, the U.S. economy was moreflexible, and Washington had more fiscal options than Tokyo. Butover the last decade, many of these advantages have dissipated. TheU.S. financial system is less resilient and less well capitalizedthan it was. After years of stubbornly high unemployment and acorporate sector that timidly holds huge cash balances in lieu ofhiring and expansion, the economy, too, shows less flexibility andresilience. And it is plain that American fiscal policy has feweroptions now than it did then.

Such comparisons no doubt introduced a sense of urgency into theFed's decision to pursue QE3 now, despite other signs that mighthave counseled a less aggressive approach. Still, such influencesand the decisions they have occasioned should in no way suggestthat America will go down Japan's path. Certainly the recent growthin money and lending offers a welcome distinction from the Japaneseexperience. Nor are there signs of deflation in the U.S. economy.Moreover, even Chairman Bernanke highlighted his confidence in theeconomy's recovery by discussing the Fed's ultimate need to unwindits remarkable policy measures. Underscoring that point still more,he has even outlined the risks should the Fed fail to take suchremedial action. But for the time being, Bernanke's worries abouteconomic weakness have created a clear bias on the side of the boldactions, much as he outlined almost 10 years ago.

For Milton Ezrati's analysis of Bernanke's warnings aboutthe risks involved in QE3, see Chairman Bernanke Tracks Risks. For more Ezrati takes onthe U.S. economy, see An Improving Trade Picture and Don't Get Carried Away by Housing Gains.