Bernanke answers half the question
With both employment and inflation far undershooting the Fed's targets this year, the big question has been whether the central bank will act. Today, at a monetary conference in Boston, Ben Bernanke offered a partial answer. The Federal Reserve is back in the game. What we don't yet know is how hard it'll play.
The problem for the central bank is that it doesn't really know how to play the game it finds itself in. The Federal Reserve is used to handling high inflation. You crank up interest rates, slowing the economy and bringing inflation down. It's also used to dealing with a weak economy in normal economic conditions: You lower interest rates and get the economy moving again. Neither strategy is applicable now.
What the Federal Reserve is not prepared for, Bernanke said in Boston, is dealing with persistently low job growth and inflation when it's already dropped interest rates as far as they can go. "Monetary policymaking in an era of low inflation has not proved to be entirely straightforward," he sighed. But the fact that bankers might wish for a more straightforward situation doesn't mean they can sit the crisis out. "Central banks, for the first time in many decades, [have] to take seriously the possibility that inflation can be too low as well as too high."
And the Fed does have other tools. The two Bernanke suggested he'll use are buying large amounts of long-term securities, which brought down interest rates during the crisis, and committing to keep interest rates low for an extremely long period of time. The problem, he admitted, is that "we are still learning about the efficacy and appropriate management of these alternative tools."
Which suggests the Federal Reserve will be cautious. And that can be a problem of its own. If the Federal Reserve intervenes but does too little and it has no effect, it will lose credibility amid fears that it cannot effectively backstop the economy. Jan Hatzius, Goldman Sachs's chief economist, worried over this dynamic at a fiscal policy conference earlier this month. "In this kind of situation," he said, "stimulus tends to be underprovided compared to what's necessary. I think we'll do quite a lot, but it will still fall short of what we need." It's up to Bernanke to prove him wrong.
Photo credit: Steven Senne/AP.
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