Nexus of Change

Toward Sustainable Habits and Durable Prosperity

Federal Reserve Chairman Criticizes Fiscal Stance Proposed by Republicans

Today’s meeting of the Board of Governors of the Federal Reserve was not only deciding on the course of interest rates between now and their next Federal Open Market Committee (FOMC) meeting but also on evaluating whether the Federal Reserve needed to inject more funds in the economy and if so, by how much. Last November, on the day following the 2010 mid-term elections, the Fed decided to inject liquidities by purchasing $600 billion of long-term securities over a period of seven months ending at the end of June, in a few days from now. This time, the Committee simply warned that it “will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate”.

Later, in a news conference, Fed’s Chairman Ben Bernanke stipulated that the risk of unemployment and inflation going back up was higher in the last part of last year than it is now. Bernanke also mentioned that long term projections on growth, unemployment and inflation are inherently unreliable because they are “influenced by non-monetary factors that evolve over time”. In monetary theory, everything in the economy is a monetary factor except politics. Indeed, the Fed’s Chairman was keen on providing an elaborated answer and much insistence on the importance of that answer to a journalist’s question on the impact of budget cuts and the timing of budget cuts. Following are some of the notes I took from the conference press that took place at 2:15 PM at http://www.ustream.tv/federalreserve. In his own terms, to the best of my ability to take accurate notes during live meetings:

“A discussion on the budget should focus on the long term, especially for entitlement reforms.”

“It is best not to have sudden and sharp reductions in the budget which wouldn’t do much to reduce the deficit in the long run because of the impact it would have growth.”

“There is already a fiscal drain. Fiscal tightening should be neutral or at best, negative, for job creation.”

“We need to take a longer run perspective with a credible plan which would prevent the deficit from rising and increase confidence (from markets).”

I believe that the non-monetary factors currently making economic projections unreliable and keeping employment growth “frustratingly low” derive from the current political climate where the Legislature and the President are unable to govern together. Ben Bernanke is clearly concerned about the political football in Washington and the concessions made to the Republican party. Bernanke became Chairman of the Federal Reserve in 2006 and such being the case, he shouldn’t be suspected of having partisan bias against Republicans.

2 comments on “Federal Reserve Chairman Criticizes Fiscal Stance Proposed by Republicans

  1. Carol S-W
    June 23, 2011

    Excellent summary of the problems inherent in this fiscal-bailout strategy, Steve. Paul Volcker said last November, “It doesn’t alarm me that they’re thinking about buying Treasuries,” he said, referring to quantitative easing. “It’s the volume which they choose to do and we don’t know what that is,” he said, adding that “if money is too easy for too long, we’ll have more” asset bubbles.” The potential inflation risks of creating asset bubbles could well bring us back to double-digit inflation of the late 70s-early 80s. Thank you for tracking these developments with such precision and can’t wait to see your next installment!!

    • Steve Osborne
      June 25, 2011

      Hi Carol, your reply is also very accurate and relevant to the circumstances I briefly described and to the underlying risks I was referring to when reporting on the Fed’s decision to helicopter more money or not. I think that doping the bond market with $600 billion was a reassuring move but was also a maneuver similar to using the joker card, something that can only be done so often.

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This entry was posted on June 22, 2011 by in Monetary Policy, Public Policy.

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