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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.

By Ezra Klein  | October 15, 2010; 11:47 AM ET
Categories:  Federal Reserve  
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Looks to me that the problem is the connection between inflation, unemployment, and outsourcing.

In the U.S. we have a large surplus of labor (ie unemployment)hence low inflation for domestic made products. Couple that with the quantities of products that are being bought but that are made overseas (where there is a large surplus of labor and lower wages). Domestic manufactures fighting to maintain some market share, slash costs however they can--such as outsourcing more work overseas. The lower interest rates stimulate demand for products, but with the outsourcing, it pumps a large percentage of dollars overseas. Which doesn't cause job creation here.

This all yields low to no inflation in the along with low to no job creation in the U.S.,increased trade deficit, and increased borrowing from overseas sources to fund the budget deficit. Unchecked it could push us into a deflationary death spin.

The Fed doesn't have a lot of tools to use on this. I expect we'll see some consideration of tariffs and like measures from the Administration to make outsourcing more costly. That would be a difficult path to follow, and would not improve things near term, but might be part of the solution.

Posted by: t_a_forrester | October 15, 2010 12:48 PM | Report abuse

I agree the problem is the intersection of inflation, unemployment, and outsourcing. For 50 years U.S. monetary policy has dominated the world economy. Outsourcing has dramatically altered the world economy. Simply put, why should I buy a Cadillac produced with $100 labor, when I can buy a Kia produced with $10 labor. In my view, outsourcing has lead to our high unemployment. Monetary policy cannot address this issue.

Posted by: rmorris391 | October 15, 2010 1:48 PM | Report abuse

The Fed and the Federal Government (President, Judicial, Congress and Senate) are so far-removed from the general middle class that they don't have any understanding of the problems that are occurring. When people worry about their jobs or don't have any then they don't spend. When the housing market is in shambles people aren't buying. Nobody is willing to take any risk at all. If the Fed cannot address those specific problems then they need to stay out of this and let the economy hit bottom and build itself back up.

Posted by: GenXer1 | October 15, 2010 1:49 PM | Report abuse

Everyone says they want to get the economy moving again, growing, or something, but nobody ever says what that economy will do.

An economy is the whole gamut of buying and selling, producing and using. The problem is that, in this country, there is not a lot of "producing" in that equation any more -- sure, there's large things like cars and generators and tanks and so on being built, but absolutely everything you see for sale in Wal-Mart, or at the Mall, is made in china or bangladesh or sri lanka.

When a vast majority of your economy depends on people buying that crap, that means a vast majority of your economy depends on sending money overseas, not circulating it around your own country. that's good for the world economy, but bad for yours because, eventually, you run out of money to send overseas because, by failing to produce anything locally, you aren't generating any local wealth.

This is not a sustainable model, and how one goes about "jump-starting" it once it breaks down is anyone's guess.

Posted by: summicron1 | October 15, 2010 2:37 PM | Report abuse

Here’s what central bankers really think about the sweaty masses that have managed to save money for their retirement:

Posted by: Baywoodfarm | October 15, 2010 2:43 PM | Report abuse

Low inflation? Are you kidding me? We have a low degree of honesty in inflation reporting. I'll buy that one.

Can anyone tell me why gold and silver are at record, off-the-map highs?

Inflation. We have inflation in every sector of the economy that cannot be shipped to China.

Posted by: hz9604 | October 15, 2010 4:32 PM | Report abuse

Outsourcing has NOTHING to do with our economic problems. NOTHING.

Posted by: hz9604 | October 15, 2010 4:38 PM | Report abuse

Trying to sort out a single source of our economic troubles is very hard, because there are many causes, some small, some large.

But one sure place to start is with the abysmally low level of economic knowledge of the average American. For example, the bloggers here complaining that inflation is really high because the price of their beer increased, or that hyperinflation is right around the corner.

While outsourcing is part of the issue, a bigger piece I think is that we have organized our economy (all of us, not just the government) around consumption and debt. In truth, the material parts we think of as traditional manufacturing continues to decrease worldwide. The part that really counts the biggest is the intellectual property part and that part is growing daily.

As an example, think of a cellular phone, or an iPod, or any other piece of consumer electronics. The physical stuff can be made anywhere, and is, by low cost workers. The most important part is the programming, and design of the parts, etc. Thats the high value part and where America continues to excel. That part is also really hard to outsource.

And yet the Republicans continue to feed the ignorant and the self deluded continue to sop it up. Amazing.

Posted by: reussere | October 15, 2010 9:35 PM | Report abuse

Reading the WSJ frontpage story on just this subject from Wednesday, I'd say that the details of the policy approaches matter far less than to NOT act cautiously. Move fast and push hard. The worst outcome is you over do it and you get inflation.

We can deal with inflation. The whole economic system is a 'pro' in containing the consequences of inflation. Deflation? We're clueless.

Posted by: Jamesaust | October 16, 2010 6:12 PM | Report abuse

Reading the WSJ frontpage story on just this subject from Wednesday, I'd say that the details of the policy approaches matter far less than to NOT act cautiously. Move fast and push hard. The worst outcome is you over do it and you get inflation.

We can deal with inflation. The whole economic system is a 'pro' in containing the consequences of inflation. Deflation? We're clueless.

Posted by: Jamesaust | October 16, 2010 6:16 PM | Report abuse

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