NRO’s eye on debt and deficits . . . by Kevin D. Williamson.

Bernanke’s Bet


As expected, the biggest news out of Fed chairman Ben Bernanke’s press conferences was not anything that he said — it was the fact that the chairman of the Fed held a public press conference for the first time ever. Meet the kinder, gentler Federal Reserve. Bernanke may not be able to do much about all those fortysomethings who’ve been out of work for 18 months, but he wants them to know he cares.

The Fed is in a difficult political situation: Its loosey-goosey money policy has not produced the growth in employment that the administration (and Congress, and the electorate, and unemployed people and their families) desire to see; at the same time, the general rise in commodities prices and the significant spikes in food and energy prices suggest that tightening eventually must come. Bernanke hinted that rather than start by raising interest rates, the Fed might move to tightening by ceasing to reinvest the proceeds from the Treasuries and mortgage-backed securities it already is holding.

Bernanke was, in his quiet way, insistent that none of the inflationary signs on the horizon are the result of the Fed’s massive money creation. Rising food and energy prices, he said, were the result of “largely non-monetary factors,” prominent among them Mideast unrest and that favorite go-to, rising demand in China, India, and other developing countries. That’s probably not an entirely adequate explanation: Mideast tensions don’t explain record prices for things like cotton and gold, and the factors leading to increased demand in the developing world (rising incomes, population growth) have been  moving in a much more gradual way than commodities prices have been.

The indicators are not pretty. The Fed’s just-released forecast for economic growth was pared back to 3.1 percent to 3.3 percent, from an earlier estimate of 3.4 percent to 3.9 percent. Meanwhile, its inflation estimate was revised significantly in the other direction: to 2.8 percent from 2.1 percent.

Higher inflation, slower growth: bad news for people with dollars in the bank. Treasury’s Timmy Turbotax says the United States is pursuing a “strong-dollar policy,” which is not entirely consistent with Helicopter Ben’s recent program of creating dollars by the trillion through quantitative easing. The Fed has a dual mandate — stable prices and maximum employment — but the relationship between interest rates, inflation, and unemployment is not nearly so straightforward as most economists thought back when the Fed was created. As Milton Friedman put it:

Monetary growth, it is widely held, will tend to stimulate employment; monetary contraction, to retard employment. Why, then, cannot the monetary authority adopt a target for employment or unemployment — say, 3 per cent unemployment; be tight when unemployment is less than the target; be easy when unemployment is higher than the target; and in this way peg unemployment at, say, 3 per cent? The reason it cannot is precisely the same as for interest rates — the difference between the immediate and the delayed consequences of such a policy.

Alan Greenspan’s tenure made the Fed chief a totemic figure: The God of the Economy. But what can be accomplished through monetary policy alone is much more limited than many people think. And what can be accomplished through monetary policy as conducted by the Fed is even more limited: The central bank has limited tools (even when it’s giving itself new ones) and significant limitations. If we were designing an agency to implement monetary policy from scratch today, we probably would not design the Federal Reserve. (We’d probably design something much worse. Why, you ask? Just a hunch.)

Because the Fed’s plans have long been telegraphed, Bernanke predicted that the discontinuation of quantitative easing this summer would not have any effect on the financial markets. That declaration had, to my ear, the quality of a prayer. He also repeatedly said that the signs of inflation were the result of “transitory” factors. But when the government is borrowing 40 cents on the dollar to finance unprecedented deficits and the Fed is creating money to make that happen, inflation is baked into the cake. And there’s a danger of vicious-circle effect: Inflation hits, the Fed has to raise rates in response, economic growth slows or reverses into a new recession, and deficits widen, fanning the inflationary flames. Bernanke met the press to reassure the public, but it is far from clear that we should be reassured about anything.

Tags: Debt , Deficits , Despair , Inflation


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