Bernanke Explains Fed's "Exit" Strategy
Last week Ben Bernanke provided details about the Fed's "exit" strategy. He did this in writing, so various economists and other commentators then published their opinions of his strategy. Without getting bogged down by the details, it all comes down to two points:
First, when it feels that inflation is heating up, the Fed plans to increase the interest rate it pays on money deposited with the Fed by banks. While this new power of paying interest on these deposits was given to the Fed only recently, it seems at first glance that it might be effective in preventing banks from loaning out too much money into the economy if there's a threat of inflation. Since the main way money is created in our economy is via the lending of banks under our existing "fractional reserve" banking system, if the Fed can slow down lending in this new way - by basically paying banks not to lend - then they can control money creation, hence control or slow down inflation. At least that's the latest theory.
Of course, the question is when do they do this? What will trigger the Fed deciding to pay out this interest to banks? That brings us to point #2. And here we find a problem as old as the Fed and one which Bernanke really didn't talk about: timing.
Bernanke didn't talk about timing much. I suspect he didn't talk about it because he really doesn't know how or when he'll know when the time is right. Why else wouldn't he talk about it? It doesn't give me a sense of confidence in this plan of his. How about you?
Then again, it seems that our esteemed representatives have confidence in the man. They just re-appointed him as head of the Federal Reserve. To their credit, it wasn't a smooth process. There was a some serious opposition for a brief period of time.
When the nomination process began, it was assumed Bernanke was in. All you heard was the if not for him and then Treasury Secretary Paulson, our financial system would have "collapsed."
But all of a sudden, there were some unusual rumblings. My take at the time was that members of Congress were hearing some of the discontent out there with the Fed - and with the Congress.
So shortly before confirmation hearings a wave of opposition swept the Congress. Other candidates appeared on the list of those being considered. For a few days, it even seemed that Bernanke was in trouble. In the end, of course, Bernanke was confirmed anyway. Just as suddenly as the wind shifted against him, it shifted back the other way. I don't know whether the politicians took the temperature of the American citizen and decided there wasn't enough to gain from a vote against Bernanke, or that the alternatives weren't very compelling. Maybe there were some sort negotiations going on behind closed doors. I have no idea.
In the end, it was much ado about nothing.
One thing did catch my attention that you may have missed. It was some of the comments regarding Ben Bernanke's character. Here's a representation of those comments, this one coming from David Kotok, chairman and CIO of Cumberland Advisors in Vineland, NJ. Here's what he said:
"You can debate his policies, but you cannot impugn his character...His record at Princeton, as a Fed governor, as an economic adviser to the president reveals not one single element of doubt on his character."
Do you find this odd? I do. I don't remember anyone ever impugning any Fed Chairman's character in the past. Take Alan Greenspan, for instance. In spite of growing criticism of his policies (after practically being declared a genius while he was head of the Fed), I've never heard anyone mention his character. (Maybe someone should. He was clearly playing a game of dissemblance and deception with his unnecessarily complicated, obfuscating style of speech.)
Nor do I remember anyone impugning Bernanke's character this time. Maybe I missed it. But oddly, I witnessed the same reaction several months before when discussing Mr. Bernanke's policies with an economist. He expressed the same sentiment: how could I imply that Mr. Bernanke wasn't an upright, honest, well-meaning man.
I was bowled over. I didn't know where the remark came from. I was talking about Fed policy, not Bernanke's character. Now here is Kotok (and some others) bringing up the character issue. Strange. What's going on here?
Anyway,the only thing that will matter is whether Bernanke pursues the policies he has clearly endorsed since he served on the Federal Reserve board, and which he has promoted as chairman: endless pumping of money into our financial system to both avoid any whiff of deflation and make sure that inflation remains an ingrained part of our monetary policy for as long as the Federal Reserve survives. But that's a subject for another time.
First, when it feels that inflation is heating up, the Fed plans to increase the interest rate it pays on money deposited with the Fed by banks. While this new power of paying interest on these deposits was given to the Fed only recently, it seems at first glance that it might be effective in preventing banks from loaning out too much money into the economy if there's a threat of inflation. Since the main way money is created in our economy is via the lending of banks under our existing "fractional reserve" banking system, if the Fed can slow down lending in this new way - by basically paying banks not to lend - then they can control money creation, hence control or slow down inflation. At least that's the latest theory.
Of course, the question is when do they do this? What will trigger the Fed deciding to pay out this interest to banks? That brings us to point #2. And here we find a problem as old as the Fed and one which Bernanke really didn't talk about: timing.
Bernanke didn't talk about timing much. I suspect he didn't talk about it because he really doesn't know how or when he'll know when the time is right. Why else wouldn't he talk about it? It doesn't give me a sense of confidence in this plan of his. How about you?
Then again, it seems that our esteemed representatives have confidence in the man. They just re-appointed him as head of the Federal Reserve. To their credit, it wasn't a smooth process. There was a some serious opposition for a brief period of time.
When the nomination process began, it was assumed Bernanke was in. All you heard was the if not for him and then Treasury Secretary Paulson, our financial system would have "collapsed."
But all of a sudden, there were some unusual rumblings. My take at the time was that members of Congress were hearing some of the discontent out there with the Fed - and with the Congress.
So shortly before confirmation hearings a wave of opposition swept the Congress. Other candidates appeared on the list of those being considered. For a few days, it even seemed that Bernanke was in trouble. In the end, of course, Bernanke was confirmed anyway. Just as suddenly as the wind shifted against him, it shifted back the other way. I don't know whether the politicians took the temperature of the American citizen and decided there wasn't enough to gain from a vote against Bernanke, or that the alternatives weren't very compelling. Maybe there were some sort negotiations going on behind closed doors. I have no idea.
In the end, it was much ado about nothing.
One thing did catch my attention that you may have missed. It was some of the comments regarding Ben Bernanke's character. Here's a representation of those comments, this one coming from David Kotok, chairman and CIO of Cumberland Advisors in Vineland, NJ. Here's what he said:
"You can debate his policies, but you cannot impugn his character...His record at Princeton, as a Fed governor, as an economic adviser to the president reveals not one single element of doubt on his character."
Do you find this odd? I do. I don't remember anyone ever impugning any Fed Chairman's character in the past. Take Alan Greenspan, for instance. In spite of growing criticism of his policies (after practically being declared a genius while he was head of the Fed), I've never heard anyone mention his character. (Maybe someone should. He was clearly playing a game of dissemblance and deception with his unnecessarily complicated, obfuscating style of speech.)
Nor do I remember anyone impugning Bernanke's character this time. Maybe I missed it. But oddly, I witnessed the same reaction several months before when discussing Mr. Bernanke's policies with an economist. He expressed the same sentiment: how could I imply that Mr. Bernanke wasn't an upright, honest, well-meaning man.
I was bowled over. I didn't know where the remark came from. I was talking about Fed policy, not Bernanke's character. Now here is Kotok (and some others) bringing up the character issue. Strange. What's going on here?
Anyway,the only thing that will matter is whether Bernanke pursues the policies he has clearly endorsed since he served on the Federal Reserve board, and which he has promoted as chairman: endless pumping of money into our financial system to both avoid any whiff of deflation and make sure that inflation remains an ingrained part of our monetary policy for as long as the Federal Reserve survives. But that's a subject for another time.
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