Risky Business: Economics and Politics Leave No Easy Options for the Fed
While he was a member of the Fed in 2002, after he left his post as an economics professor at Princeton University, Bernanke acquired the nickname "Helicopter Ben" for referencing economist Milton Friedman's famous "helicopter drop" theory of monetary policy in a how-to-prevent-deflation speech.
In his excellent work, A Monetary History of the United States, Friedman argued that, if all else failed to check deflation, the Fed could always drop money from a helicopter to encourage spending.
Despite Bernanke's nickname, you shouldn't start scanning the skies for formations of helicopters flying in your area, but that doesn't mean the nation's economic condition is not serious.
Demand in the U.S. is already weak, and it appears to be either stagnating or ebbing lower. The housing sector, now without the support of the federal home buyer tax credit, regressed this summer. New home sales fell to an all-time low in July, and existing home sales have decreased substantially. Retail sales have been tepid. Hiring by businesses large and small has been inadequate in the past year. And now the manufacturing sector -- which has to-date been the shining star in the expansion -- has cooled. Put it all together and the picture is one of an economic recovery that's inching along, and if exports and business investment cool in the months ahead, the economy could fall in to a double-dip recession.
Economic and Political Headwinds
Now, one might think the above offers a slam-dunk case for Bernanke to increase in monetary stimulus -- but it's not that simple. There already is a great deal of stimulus in the financial system, both conventional and nonconventional (quantitative easing). The Fed's balance sheet has more than doubled to over $2.3 trillion.
Beyond that, there are ample private sector's resources: Corporations alone are sitting on a huge chunk of cash, about $1.85 trillion. So there's already enough money in the system, and given the right business conditions, that capital could be deployed and flood the commercial system in a hurry. All those dollars on the sidelines -- and the threat of a large, rapid increase in inflation that they pose -- is one reason the price of gold has remained so high, despite a U.S. economy that's barely growing and operating well below its potential. The "more monetary stimulus" option is not without economic risks.
Whatever his next move, Bernanke faces not only economic risks but political ones. Congressional Republicans, emboldened by the prospect of large House and Senate seat gains in the upcoming November elections, have already been highly effective at spreading disinformation.
Such false ideas as "The credit market intervention by the Fed hasn't worked" (it did, and prevented a far worse credit crunch) and "The fiscal stimulus has been ineffective" (only true if one defines going from about 500,000 jobs lost per month to small monthly job gains as 'ineffective') have taken root in the minds of a large percentage of Americans. Who knows what Republicans on Capitol Hill would encourage their supporters to believe if Bernanke increased stimulus or used additional quantitative tools to help get the U.S. economy growing at an adequate rate?
Cash Payments For All? No Chance
True, the Federal Reserve is an independent central bank, but that's not to say it's not subject to political pressures, or that its board isn't fully cognizant of the political climate when it makes its decisions. That climate is, to put it diplomatically, tense. In blunter terms: Polarized, caustic, and at-times loopy. Right-wing extremists, whipped up by the likes of Glenn Beck and Rush Limbaugh, are structuring the political debate and guiding many if not most policy stances of the Republican Party. It's an atmosphere that's more likely to favor a return to the gold standard and more tax cuts for upper-income groups than another Keynesian program to stimulate GDP growth.
With the above as context, suggestions that the Fed make cash payments to individuals or invest in stocks directly are nonstarters. Universal cash payments to individuals by the Fed? This summer, Congress struggled to extend ordinary unemployment benefits to households that really need them.
The task that Bernanke faces now is to devise a solution that increases demand, facilitates commercial activity and encourages job growth, while simultaneously not creating conditions ripe for rising inflation. Incidentally, whatever he proposes must also be effectively inoculated against the likely automatic -- and in some cases, irrational -- attacks it will face from Republicans and other conservatives.
And a solution like that doesn't come easy.