Search This Blog

Monday, April 30, 2012

Bernanke, the FOMC and Two Cliffs

The Federal Open Market Committee issued its statement on interest rates, the economy and monetary policy on April 25, and did not offer any surprises. 
The FOMC sees the economy “expanding moderately,” and sometime in the future, expects it “to pick up gradually.”
As for inflation, no real concerns could be detected. The FOMC stated, “Inflation has picked up somewhat, mainly reflecting higher prices of crude oil and gasoline. However, longer-term inflation expectations have remained stable.”
And as for policy, it was no change. The FOMC said that it “expects to maintain a highly accommodative stance for monetary policy. In particular, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.”
Meanwhile, in his press conference, Fed Chairman Ben Bernanke did warn lawmakers about a “fiscal cliff” at the end of this year if all of the scheduled tax increases and government spending cuts were to go into effect. He said “that would be a significant risk to the recovery.” As The Wall Street Journal reported, “If lawmakers allow the tax cuts to expire and the spending cuts to take effect, ‘there is absolutely no chance that the Federal Reserve would be able to have the ability whatsoever to offset that effect on the economy,’ Mr. Bernanke said at a news conference Wednesday, following a two-day meeting of the Fed's policy-making committee.”
Actually, the economy faces two possible cliffs.
Bernanke is half right about the fiscal cliff. Scheduled tax increases for next year create uncertainty now, and would deal a devastating blow to entrepreneurship, investment and the economy if allowed to go into effect. At the very least, Congress needs to make the 2001/2003 tax relief measures permanent, and repeal the scheduled ObamaCare tax increases.
As for government spending cuts, however, those actually would not have a negative impact on the economy, contrary to what is alleged by the Keynesian thinking prevailing among the Obama administration, many in the media, and apparently, Ben Bernanke. Reining in federal spending means leaving resources in the private sector, where they would be used far more productively.
But Bernanke does not want to talk about the monetary cliff that stands as another major risk or threat to the economy.
The Fed chairman has chosen to ignore the straightforward economic reality that inflation always is a monetary phenomenon. That goes for the stepped-up inflation we have experienced since late 2010. This recent inflation and the risk of going off a monetary cliff go to the troubling challenge that Fed opened the monetary floodgates in late summer 2008 in way that was never done before, and has only taken very minor breathers since. That translates into a very real threat of much higher inflation.
Policymakers need to step back from these dangerous cliffs, and that includes the Federal Reserve getting back to focusing on price stability, rather than trying to manipulate the economy due in large part to trying to counter bad spending, tax, and regulatory policies. When the Fed loses sight of price stability, and tries to gin up or prop up the economy, that effort not only fails (as we have seen), but it also creates additional risks.

Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council. His new book is “Chuck” vs. the Business World: Business Tips on TV.

No comments: