March 13 (Bloomberg) -- Want the inside skinny on Federal Reserve Chairman Ben Bernanke's next moves as he battles to avert recession, bank bankruptcies and the collapse of capitalism? His detailed playbook is freely available from the Fed's Web site.

In November 2002, when Bernanke was merely a Fed governor, he gave a speech about ``Deflation: Making Sure `It' Doesn't Happen Here.'' More than five years on, the text provides a step- by-step guide to the Fed's reaction to the current credit crisis, and hints at the tricks left up the central bank's sleeve.

The speech is relevant even though two of its premises -- a general decline in consumer prices and a benchmark central-bank rate that's close to zero -- don't currently apply to the U.S. experience. Bernanke detailed the Fed's likely response once the blunt instrument of cutting borrowing costs had lost its potency to revive the economy -- which is exactly the situation the central bank finds itself in now.

``When inflation is already low and the fundamentals of the economy suddenly deteriorate, the central bank should act more preemptively and more aggressively than usual in cutting rates,'' Bernanke said. ``By moving decisively and early, the Fed may be able to prevent the economy slipping into deflation.''

That seems to encapsulate the actions so far, particularly the emergency cut enacted on Jan. 22 when the Fed wasn't scheduled to meet. The futures market, moreover, tells us there's a 72 percent chance that the Fed will lower its key rate to 2.25 percent from 3 percent when it next meets March 18. Monetary policy, however, seems impotent just now.

Threats to Stability

``At times of extreme threat to financial stability, the Federal Reserve stands ready to use the discount window and other tools to protect the financial system, as it did during the 1987 stock market crash and the Sept. 11, 2001, terrorist attacks,'' Bernanke said in his speech.

Unlike in 1987 and 2001, propping the discount window open hasn't boosted the flow of money around the economy in recent months. The Fed can cut the cost of cash; it hasn't yet been able to boost the availability of funds.

This week's $200 billion offer to exchange pristine Treasury securities for tarnished mortgage debt is a tacit recognition by the Fed that slashing its key rate from the 5.25 percent level that prevailed in September has failed to thaw the mortgage market. Bernanke presaged just such a bond-market move in his 2002 talk.

``Another option would be for the Fed to use its existing authority to operate in the markets for agency debt,'' he said. It could offer ``fixed-term loans to banks at low or zero interest, with a wide range of private assets, including, among others, corporate bonds, commercial paper, bank loans and mortgages deemed eligible as collateral.''

`Fire Sales'

Bernanke cited a 1933 study by Yale economist Irving Fisher, who he said emphasized ``the potential connections between violent financial crises, which lead to `fire sales' of assets and falling asset prices, with general declines in aggregate demand and the price level.'' That sounds horribly familiar, doesn't it?

``A healthy, well-capitalized banking system and smoothly functioning capital markets are an important line of defense against deflationary shocks,'' Bernanke said. Well, that line of defense has been well and truly breached and lies in shards.

``The U.S. government has a technology called a printing press that allows it to produce as many U.S. dollars as it wishes at essentially no cost,'' Bernanke said. ``A determined government can always generate higher spending and hence positive inflation. Sufficient injections of money will ultimately always reverse a deflation.''

Passing it On

If the recipients of those cash injections hoard the largess instead of passing it on to borrowers in the wider economy, there's a problem.

So what other unconventional measures might we expect from Bernanke's Fed in the coming months, based on the speech that tagged him as ``Helicopter Ben'' because of its reference to Milton Friedman's phrase about helicopters dropping money into the economy?

``One approach, similar to an action taken in the past couple of years by the Bank of Japan, would be for the Fed to commit to holding the overnight rate at zero for some specified period,'' Bernanke wrote. ``A more direct method, which I personally prefer, would be for the Fed to begin announcing explicit ceilings for yields on longer-maturity Treasury debt, say, bonds maturing within the next two years.''

Yield Guarantees

The central bank would pledge itself to unlimited purchases of Treasury notes to prevent yields from rising above a preset target level, Bernanke said. ``If operating in relatively short- dated Treasury debt proved insufficient, the Fed could also attempt to cap yields of Treasury securities at still longer maturities, say three to six years.''

In the 1940s, ``the Fed maintained a ceiling of 2.5 percent on long-term Treasury bonds for nearly a decade,'' Bernanke noted. It also enforced caps on 12-month Treasury certificates and 90-day Treasury bills during part of that period.

The speech also suggests that European Central Bank President Jean-Claude Trichet's pleas for the U.S. to speak out against the dollar's decline to a record against the euro will continue to fall on deaf ears.

``It's worth noting that there have been times when exchange-rate policy has been an effective weapon against deflation,'' Bernanke said, citing the 40 percent devaluation of the dollar against gold enacted in 1933 to 1934. ``The devaluation and the rapid increase in money supply it permitted ended the U.S. deflation remarkably quickly. Monetary actions can have powerful effects on the economy.''

So, brace yourself for a Fed funds rate close to zero, interest-rate-free loans in exchange for a much wider range of debt collateral, and further dollar weakness. And, if Helicopter Ben sticks to the script, the Fed might even guarantee the value of two-year Treasury notes. Strange days indeed.

(Mark Gilbert is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: Mark Gilbert in London at magilbert@bloomberg.net

Last Updated: March 12, 2008 20:01 EDT