Sunday, August 26, 2012

Speak the Truth Ben

On August 1, Darrell Issa, Chairman of the Congressional Committee on Oversight and Reform, wrote a 10-page letter to Ben Bernanke, Chairman of the Board of Governors of the Federal Reserve System. In this letter, Issa asked 22 specific questions about the economy and what it takes to bring it out of its current malaise. Issa extensively cited the opinions of Allan Meltzer (an economics professor at Carnegie Mellon University), David Stockman (former Director of the Office of Management and Budget), and Andy Kessler (a noted investor). All three individuals have been critical of Federal Reserve policy.

Bernanke's answers to Issa's questions are revealing, often more for what they don't say than for what they do say. For example, in his first question, Issa asks if forcing interest rates even lower than they already are will do much good to promote growth and reduce unemployment. Without actually saying so, Bernanke implies that the answer is no. Issa's next three questions are about bank reserves. He wants to know if these reserves are excessively high and if they are helping the U.S. economy. Bernanke dances around those questions and instead focuses on how reserves got so high. Reading between the lines, however, it seems that he thinks that, yes, reserves are too high and, no, high reserves are not doing much good to help the economy. 

Another point that seems to come through loud and clear is that the Fed's so-called dual mandate (maximum employment and stable prices) is making the Fed's job extremely difficult. Of course, Bernanke does not say this directly. Nonetheless, he seems keenly aware that pressure to maximize employment today is increasing the risk of significant inflation tomorrow.

The Fed Chairman is clearly caught in the middle of an ideological debate taking place in Congress. Democrats want him to continue doing whatever it takes to reduce interest rates and maximize employment. Republicans want him to admit that current monetary policy risks significant inflation and that it is no longer doing any good anyway. Republicans want Bernanke to say loud and clear that the economy's problems must be addressed through fiscal policy.

Indeed, it should be crystal clear to every observer that the Fed has done enough already. It has ballooned its balance sheet and it has driven interest rates to historic lows. It is impossible to believe that the economy is suffering from excessively high interest rates. It also impossible to believe that reducing rates even further will do any good. On the contrary, low rates are punishing savers (especially older Americans who tend to keep their capital in bank accounts) and increasing the risk of future inflation. Perhaps Bernanke finds a need to be "political" when responding to inquiries from politicians. It would be refreshing, however, if he'd simply say what he really believes.