Is Ben Bernanke a hawk in dove's clothing? After yesterday's historic press conference, several economic commentators have criticized the Federal Reserve's concern that inflation could soar if it continues to expand monetary stimulus aggressively after June. Those critics point to unemployment, saying that the Fed must continue to pour money into the economy until joblessness drops to a more manageable level. Are they right?
First, let's review the Fed's monetary policy dual mission: to pursue maximum employment and stable prices. To be sure, employment is far from maximized -- the unemployment rate remains near 9%. Inflation is currently subdued, but the problem with increasing money supply is that it can cause inflation if too much is released and can't be swept up before the economy starts heating up. In a situation where the economy is recovering at a moderate clip but unemployment remains high, the Fed has to pick which is more important: trying to push down unemployment or trying to keep inflation tame.
Does this mean that the Fed is more worried about inflation than unemployment? Matthew Yglesias from the American Prospect thinks so. After explaining the concern that the Fed may have to create a new recession if inflation gets too high, he writes:
That's not a totally crazy concern, but it reflects a curious assessment of risks: Technically, America's central bank has a "dual mandate" and is supposed to both avoid inflation and elevated unemployment. In practice, it takes a very lopsided approach. Bernanke is clearly willing to act to stave off total economic collapse, but he's deeply unwilling to improve the overall economy in any way that might even slightly risk sparking inflation. Imagine a tightrope walker with a net on his left side and a fiery pit to his right. He's going to try to stay on the rope. But he's going to make damn certain that if he falls, he falls to his left.
The Fed Has Been Anything But Passive
This view suffers from some selective memory. Remember 2008? In September of that year, as the financial crisis was looming, unemployment was just 6.2%. But the Fed saw a storm coming. So at that time it began ramping up its balance sheet. Then, the size of its balance sheet was a mere $907 billion. By the time the current round of monetary stimulus ends in June, it will have ballooned to $2.75 trillion. That's a 203% increase in less than three years.
And that's not all. Late that year, it cut the federal funds interest rate to approximately zero. It's been there for nearly two-and-a-half years.This is also unprecedented.
These efforts were extraordinary. No Fed in the history of the U.S. has taken such ambitious measures to prop up the U.S. economy. To call Chairman Bernanke and his peers inflation hawks would be to look at its decision to finally put the brakes on stimulus currently and totally ignore the measures it took over the past three years. They absolutely helped to keep the unemployment rate lower than it would have been. If credit had dried up for an extended period, firms would have had to lay off millions more people. Eventually they must find a way to tighten quickly enough when the time is right to avoid massive inflation, but that's a risk they were willing to take.
The Fed Hasn't Given Up on Stimulus Entirely
Moreover, just because the Fed isn't engaging in a third round of quantitative easing doesn't mean that it's gone back to business as usual and will focus solely on the price level. It has no intention of shrinking the size of its balance sheet in the near-term. It won't even allow its maturing securities to slowly run off, so it's reinvesting them to keep its balance sheet size stable. Additionally, it refuses to even tweak its statement's language about keeping interest rates near zero for anything other than "an extended period."
Just because the Fed isn't completely disregarding inflation doesn't mean that it's completely disregarding the unemployment problem. If it was really that worried about inflation and so unconcerned about unemployment, then it would already have begun tightening policy. It has not and has no intention to do so in the near-term.
The Fed's Just Being Practical
In the excerpt above, Yglesias seems unconcerned about inflation. What harm could a little inflation do? Well, a little inflation probably wouldn't do too much harm, but a lot of inflation would -- and that's what the Fed's worried about. A very high rate of inflation could be the nation's fate if the Fed isn't careful about its exit. It has pumped an enormous amount of money into the system and the central bank must be very careful to ensure that it doesn't end up inflating the currency.
Still, Yglesias says that even moderate inflation would not be a big deal if temporary. The Fed would just have to make sure the market understands that the high rate of inflation is only until unemployment is low again. Unfortunately, markets aren't that easy to please. If global investors learn that the U.S. simply intends to inflate its way out of every severe recession, suddenly the dollar and U.S. debt will become suspect. They will only be strong when the U.S. is doing well, but when things start going badly, investors will expect their values to plummet. The Fed doesn't want to live in a world like that, and neither should we.
Ben Bernanke Isn't Harry Potter
Finally, one of the most ridiculous questions at Bernanke's press conference yesterday asked why the Fed wasn't doing more to curb long-term unemployment. The answer is quite simple: the Fed has absolutely no control over long-term unemployment. Bernanke said this in response, though in a kinder, gentler way. At best, the Fed can make credit conditions more conducive to business. Then, it's up to businesses to use the credit available to them. If they don't, then employment won't improve.
This is one of the reasons why the current round of quantitative easing hasn't done more. Credit really isn't the problem: firms just aren't sensing enough demand for its products from consumers or other firms to ramp up hiring. As long as that's the case, the Fed could buy $1 billion in Treasuries per month and it wouldn't help: if Americans aren't buying, firms aren't hiring. Sadly, the Fed can't just wave a wand, say an incantation, and make unemployment disappear.
The Fed is taking the right approach by being prudent when it comes to stimulus. If anything, it is taking a moderate view of inflation fears. There are some economists who criticize the Fed for not tightening sooner, just as there are other critics who want the Fed to loosen. So seeing the Fed somewhere in the middle probably indicates a humble stance: it knows it limits and understands it could do more harm than good if it pushes its luck.