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Bernanke's Dilemma

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Amid strident and stern and sensible pleas for more federal assistance to the economy, Fed Chair Ben Bernanke declined on Thursday, described in a piece by Sewell Chan in the New York Times. The reality alluded to (or sometimes not) in the article is that the Federal Reserve Bank is almost out of trumps, cards, chips, and its seat at the table in jeopardy. Well, actually there is nothing to take the place of the nearly exhausted Fed, so I guess Mr. Bernanke will continue to sit, whether he can ante up or not.

The Fed has the following responsibilities under the law, as described in the Wikipedia description:

Conducting the nation's monetary policy by influencing monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates.

Supervising and regulating banking institutions to ensure the safety and soundness of the nation's banking and financial system, and protect the credit rights of consumers.

Maintaining stability of the financial system and containing systemic risk that may arise in financial markets.

Providing financial services to depository institutions, the U.S. government, and foreign official institutions, including playing a major role in operating the nation's payments system.

You will notice that the powers inherent in the fulfilling these responsibilities are limited and revolve around money supply and credit. With respect to money supply the balance against inflation is maintained by keeping the money supply growing proportionately to the population, particularly the productively employed sector of the general population. Notice that both inflation and deflation have their own logic and can with sufficient panic and distrust in the economy get out of the control of the Fed.

With respect to credit the Fed stands at the apex of a system wherein each level of lending institutions is dependent on the rate at which the Fed sets its over-night and other rates. Currently there is about one and half percent of rate structure to play with before the Fed has no handle or grasp or control on lending whatsoever. So, quickly, Bernanke's decision to not intervene further in credit is based fundamentally on the fact that he has very little leverage on the system and must wait for natural growth and demand to occur, whereupon his single handle will magically appear and a healthy control system will rematerialize within the logic of supply and demand.

The Fed has other "powers" such as running the "clearings" of checks and other instruments. There is no real monetary or fiscal control here, unless there is a serious panic. Then the Fed could shut down the system in order that the players can take a deep breath and reconsider their options in the light of panic. Emergency loans to specified institutions are possible, but these are mostly designed to avert bottlenecks that occur because of human or system failures elsewhere and to coordinate with FDIC and its cousins.

Understanding Bernanke's dilemma requires at least a cursory look at the rest of the world. The rest of the world begins in Europe in the EU where, as everyone by now knows that the southern and eastern tiers of countries are in various kinds of fiscal emergency, Greece because of, among other things, pension spending that is not supportable by the taxable (actually taxed) gross domestic product. But the problems in the Baltic states and east central Europe do not suggest strength either. Germany and the U.K. are the stronger members of the EU, but neither is the deep pocket that the rest of the EU needs. They are not deep because the politics of fiscal constraint is winning against the more likely to succeed policy of central stimulation.

In the U.S. the same battle is afoot, but with not nearly the number of active troops on the conservative side ... for now ... but with everyone nervous about piling up debt on debt for a someday-recovered economy to pay off. It is a game of "chicken" where the decision to put on the brakes is crucial, but the two alternatives--stopping too soon or stopping too late--are fatal.

If the federal government chickens out and repeats the errors of FDR and his Congresses of 1936-37 then the economy is almost completely sure to double dip into a great or greater recession, enter a period of deflation, yet fail to recover jobs, productivity, or any semblance of healthy growth. Moreover, and crucially, the zillions of dollars spent in the first wave of federal "bailout" and economic assistance will evaporate from the economy as the deflation deepens and the economy does not recover. In essence the debt we have nervously piled up becomes a dead weight around our necks, with each dollar of debt more difficult to pay off.

The imagery of games of "chicken" sometimes has the loser plunging over a cliff onto the rocks below as the winning car screaches to a stop just before the lip of the cliff. So, in our economics, if we do not curtail spending at just the right time, we risk plunging the entire economy into ruinous debt that exceeds our economy's ability to produce full payments on that debt. It becomes uncontrollable and politics being what it is, as cities and states default on their debt the strong urge is to IN-flate our way out of the situation, leaving huge masses of the population experiencing "sticker shock" on food, transportation, and housing. A Weimar U.S. would be a disaster, too.

So, Bernanke has his wary eye on Berlin and London hoping that the best minds there see the correct time and place to being braking their own programs of stimulating their economies. He also, as the article points out, has an eye on the domestic indicators: unemployment, housing starts, domestic production, etc. He must not be sleeping too well these days, because the numbers are not good, and will not be for some time ... a time during which we will have the up-coming mid-term elections, two year later the presidential election, and two years after that another mid-term. All such elections are decisively affected by the state of the economy.

The big question is, then, what are the alternatives to the exercise of the powers of the Federal Reserve System? The answer throws you back into the maelstrom of domestic politics. Congress is voting on a strictly partisan basis currently to extend unemployment benefits and the administration is doing what it can with the domestic budget to get Main Street-sustaining money out into the place where politics originates--locally. But will it be enough, and will the press and pundits understand that this particular game of chicken is unlikely to have a Disney ending? Someone is going to get "killed" if the administration does not handle this exactly right. If the Congress goes Republican then the last two years of an Obama administration will have one arm tied behind its back. How then to manage the tricky business of saving the economy? Frankly, I don't see how any administration could do it without Congress cooperating.


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James R. Brett, Ph.D. taught Russian History before (and during) a long stint as an academic administrator in faculty research administration. His academic interests are the modern period of Russian History since Peter the Great, Chinese (more...)

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