Fisher Investments Editorial Staff
Monetary Policy, Inflation

Juggling Hats

By, 07/22/2009
Story Highlights: 
  • In congressional testimony Tuesday, Fed Chairman Ben Bernanke noted economic conditions and credit markets continue improving, but the economy remains weak. 
  •  It's not yet time to tighten monetary policy, but when that time comes, many Fed facilities will automatically lapse, reducing overall liquidity.
  • Bernanke appears to be building his resume in anticipation of possible reappointment early next year, but his career motivations aren't mutually exclusive with smart policy.



In Lewis Carroll's Alice in Wonderland, the Mad Hatter riddles, "Why is a raven like a writing desk?" Turns out, he doesn't have an answer. Given the role's reputation for public obfuscation, the Hatter would probably make an excellent Federal Reserve chairman. Perhaps even more so because our latest Fed chairman, Ben Bernanke, loves hats. In his Tuesday testimony to Congress and a Wall Street Journal editorial, Bernanke juggled three: Fed chairman, professor, and politician.


Fed Chairman Bernanke told Congress economic conditions and credit markets are improving. He noted interest rate spreads continue narrowing, private capital is returning, banks have raised considerable capital, corporate bond issuance is up, and stock markets have risen since March—at which point, Politician Bernanke slyly interjected, "Many of the improvements in financial conditions can be traced, in part, to policy actions taken by the Federal Reserve to encourage the flow of credit." Well done, sir!


In light of improved conditions, a prevalent view holds it's time to preemptively tame inflation by reining in the money supply. Swapping hats, Chairman Bernanke respectfully disagreed. The economy is still weak. Countering easy monetary policy, overall capacity utilization remains low. Excess reserves, for instance, are high according to Bernanke: "…reserve balances now total about $800 billion, much more than normal." That means banks still perceive more risk than reward in the economy and thus prefer holding funds to deploying all that liquidity.


As economic recovery gradually boosts capacity utilization and prompts deployment of excess reserves, rampant inflation could be a risk—if the Fed's balance sheet doesn't shrink in time. But as we've said before, when the economy improves and the programs are no longer needed, the loans supplied by the Fed are repaid and the programs end. Chairman Bernanke corroborated this view by noting the Fed's "policy measures will unwind automatically as the economy recovers and financial strains ease, because most of our extraordinary liquidity facilities are priced at a premium over normal interest rate spreads." In fact, it's already happening: "…total Federal Reserve credit extended to banks and other market participants has declined from roughly $1.5 trillion at the end of 2008 to less than $600 billion, reflecting the improvement in financial conditions that has already occurred."


Beyond auto-terminating programs, there are plenty of other tools at the Fed's disposal. Professor Bernanke rambles in depth about these tools in his Wall Street Journal editorial. But most aren't worried about whether the Fed has enough tools to control the money supply; rather, will political pandering pressure policy? Sure, it's possible. After all, Bernanke is up for reappointment early next year, and some recent communications smell of resume-building.  But remember, with those auto-ending Fed facilities, Politician Bernanke's career aspirations aren't necessarily mutually exclusive with smart policy. Further, easy money could well remain appropriate until after a new (or old) Fed head is announced. And because monetary policy needn't be pinpoint accurate, even slightly delayed discretionary Fed actions won't likely miss the mark by much.


There's always a chance the Fed will make a policy error down the road. But the risk of inflation is still distant and, recall, much of the world was panicked about deflation just a few months ago. Between now and then, we may witness a surprisingly flexible Fed—Mad Hatter Bernanke's mesmerizing hat juggling notwithstanding.



*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.


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