There is a disturbing report in The New York Times this evening: Senator Reid, the Senate Majority Leader, is reported to have said publicly that "he had decided to support Mr. Bernanke [for a new term as chairman of the Federal Reserve] with trepidation and only after he received a commitment that the Fed chairman would take additional steps to increase the flow of credit to middle-class Americans." (Emphasis mine.)
I take no position on whether Bernanke should be confirmed; it would be inappropriate for me to comment publicly on a federal personnel matter and anyway I don't think I'm sufficiently well informed to have a responsible opinion. But I am worried about his having committed--if he did, for we have as yet only Senator Reid's word for it, and there is no doubt room for misinterpretation and different interpretations--to taking additional steps to increase the flow of credit to middle-class Americans. The only ways in which the Federal Reserve can do that, I should think, is by either reducing interest rates further or using its regulatory authority to compel banks to start lending their excess reserves. (The Fed is paying interest on those reserves; by ceasing to pay interest, it might induce greater lending--or less, because it would be depriving the banks of a secure stream of income.) The problem is that more credit, implying more money in circulation, increases the risk of a future inflation.
Suppose six months from now banks are lending much more than at present, so that the amount of money in circulation is increasing, and the velocity (rate of circulation) is also increasing as people spend more. In those circumstances, there will be a risk of inflation. The Fed can control the risk by increasing interest rates, but that will slow economic activity. Suppose the unemployment rate is still high, and with the slowdown in economic activity caused by a tightening of monetary policy, it rises. There will be howls. Will Bernanke be able to stick to his guns, as Volcker did in 1982, when unemployment hit 10.8 percent? Or will his "commitment" to Senator Reid deter him? If it does, the inflation may get out of hand.
All this is speculation; I have no crystal ball or keen insight into Bernanke's thinking or character, let alone an ability to forecast the course of the economy over the next year (or, for that matter, of the next week). But I am troubled that a nominee for Fed chairman should commit himself to follow an "accommodative" monetary policy as a quid pro quo for confirmation. I hope Senator Reid misunderstood him.
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