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The Neolibertarian NetworkCan The Fed Pull It Off?
David Gitlitz writes about the future tasks of the Fed in their super-expansionary use of their balance sheet to manage the financial “crisis”:
It is likely, however, that this extraordinary exercise in monetary ease will at some point have significant inflationary consequences. And the Fed will face a big dilemma if this happens before the market is restored to stability and the economy has emerged from recession. In this scenario, the Fed would have to either tolerate significantly higher inflation for a period, or tighten its policy in the face of still-significant weakness in the economy and markets.
[...]
On that score, a surprisingly honest acknowledgement of the potential quandary facing the central bank came last month from Jeffrey Lacker, president of the Richmond Fed. Lacker told a group at the College of Charleston that the potential inflationary impact of the Fed’s actions “depends on our skill at the Federal Reserve in withdrawing the stimulus in a timely way. That is a very delicate, very hard policy.”
Lacker referred to the “spotty” nature of an economy in recovery, and asked, “Do we keep policy easy and stimulative because of the sectors that are lagging behind . . . or do we get ahead of the curve? It’s going to be a tough call.”
Lacker has strong anti-inflation credentials. So to hear him describe the Fed’s looming choice as a “tough call” seems to raise the probability that the Fed will accede to an inflationary — and unnerving — outcome.
My bet is that they’re going to do it poorly in any event.
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The Disappearing Punchbowl Trick is a great trick if you can pull it off. But it seems the Federal Reserve has not really mastered it yet. I know of no instance where the trick succeeded without some serious economic embarrassment. Even Volcker, for all his magical powers, was rather clumsy in the execution and ultimately crashed the entire economy.
Bernanke’s term as Federal Reserve Board Chairman expires on January 31, 2010. Around that time, or even a few months before, he should be trying the Disappearing Punchbowl Trick. But unemployment, being a lagging indicator of economic health, will likely still be on the rise. Thus, I rather doubt history’s most corrupt and incompetent Congress and Executive branch will like or understand what Bernanke is attempting to do. Their only concern will be their chance for reelection in November.
In short, we are facing a very bad situation. Political considerations will likely trump the timely execution of the Disappearing Punchbowl Trick, and Bernanke will have to postpone his demonstration until after January. This delay may commit the economy to needlessly suffering a sickening bout of inflation for a year or 18 months. Either that or Bernanke will be so pressed for time, he will hurry himself and blow the trick. The infamous Double Dip Recession would result.
When dealing with history’s most corrupt and incompetent Congress and Executive branch, there is, of course, a worse economic scenario: They will not reappoint Bernanke to another term as Chairman.
Ah, the devil you know argument. I’m with you, Max. I’ve never seen them do it right in the three decades I’ve been paying attention either.