Bernanke – Repeating Previous Federal Reserve Mistake?

Tuesday, December 8, 2009

1152453_signalLast week, Ben Bernanke, Chairman of the Federal Reserve, testified before congress. The purpose was to report on Fed activities, indicate future plans and provide rationale for his being confirmed for a new term. There is one statement he made that I would like to highlight because it was a policy that exacerbated our inflationary problems in the late 1970s and early 1980s…

In Bernanke’s testimony last Thursday, he said,

“My colleagues on the Federal Open Market Committee and I are committed to implementing our exit strategy in a manner that both supports job creation and fosters continued price stability.”

The truth remains that no one can serve two masters well. The Fed cannot pursue job creation and price stability at the same time. The problem is that employment follows economic improvement. So, if the Fed keeps money easy until that time, it will have done so too long into the growth phase.  The surplus funds would let growth in leverage (borrowing and lending beyond the Fed) become entrenched. Once that cycle begins, it is hard to stop without the Fed raising interest rates above normal, thereby squeezing the economy.

Bernanke is also trying to keep the Fed independent, and that is a key characteristic of the Fed’s effectiveness. If it had to take only popular actions, the Fed couldn’t act wisely in advance. It would have to wait until a problem was evident before acting. That’s the perfect recipe for economic gyrations that damage long-term growth. However, Bernanke, to win confirmation, must please congress, and that means bringing job creation into the Fed’s role. It was a mistake in the past, and it could be a mistake now.

As I have discussed, we’re already on the road to employment gains. Keeping the money accelerator depressed at this point to add jobs increases the risk that the brake will have to be hit later on.

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