Economics, Monetary Policy

Ben Bernanke, backed in a corner

Ben Bernanke, the chairman of the Federal Reserve, has been having a rough time lately. He’s received criticism from politicians, pundits, and other central bankers, and has been attacked for doing both too much and too little. The actions of the Federal Reserve have not received this much scrutiny in a long time, undoubtedly due to the rising scope of their actions and the heightened sense of urgency surrounding them.

I don’t wish to discuss the legitimacy of the Fed’s past actions. Instead, I want to discuss the actions they will have to take in the next few years. As the economy begins to tentatively recover, the Fed must walk the thin line between encouraging growth and causing uncontrollable inflation. And as Bernanke’s critics reveal, there are arguments for doing more to address both issues.

For inflation hawks, images like this are seriously frightening:

Such a dramatic increase in money supply would lead to dangerous inflation during any normal economic time. However, these are not normal economic times, and expanding the money supply cannot cause inflation while demand is suppressed. So, while the Fed should keep an eye on inflation as the economy recovers, there has been little evidence that rising inflation will warrant action in the short term.

On the other hand, the weak economy still has far to go before it is fully recovered. Improvements in employment and output are good news, but aren’t enough to bring a rapid recovery. More importantly, the lingering weakness stems from a lack of demand, which the Fed is ill-suited to address. Like the proverbial dehydrated horse, it can’t force the markets to expand growth, and further expansionary policies would only serve to feed inflationary pressures when the markets do recover.

So what can Bernanke and the Fed do? I would suggest the simple task of waiting, and making sure not to make promises they aren’t prepared to keep. While a reasoned resolution of Europe’s debt crisis, or a similar solution to our own debt situation, would be helpful, there is little Bernanke can do other than make speeches. He would be best off to let monetary policy be, and prepare a response to rising inflation or a Europe-related confidence crisis; problems that the Fed is well suited to deal with.

Joe McClintock is an intern with the economics department at AEI.

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