Federal Reserve Board Chairman Ben Bernanke and his Fed colleagues must begin to address investors' concerns about inflation in more concrete terms than he did in his speech at Morehouse College in Atlanta last week.
In his speech, he addressed four questions about the financial crisis: How did we get here? What is the Fed doing to address the situation? Does the Fed's aggressive response risk inflation down the road? Why did the Fed and the Department of the Treasury act to prevent the bankruptcy of some major financial firms?
While Mr. Bernanke used about 860 words to discuss the first question, about 1,230 words to address the second and 1,100 words to address the fourth, he used only about 570 words to discuss the danger of inflation and what the Fed might do to prevent its seeds from germinating and growing wild in the economy.
Specifically, he said in part: "Although inflation seems set to be low for a while, the time will come when the economy has begun to strengthen, financial markets are healing, and the demand for goods and services, which is currently very weak, begins to increase again. At that point, the liquidity that the Fed has put into the system could begin to pose an inflationary threat unless the [Federal Open Market Committee] acts to remove some of that liquidity and raise the federal funds rate.
"We have a number of effective tools that will allow us to drain excess liquidity and begin to raise rates at the appropriate time. That said, unwinding or scaling down some of our special lending programs will almost certainly have to be part of our strategy for reducing policy stimulus once the recovery is under way.
"We are thinking carefully about these issues; indeed, they have occupied a significant portion of recent FOMC meetings. I can assure you that monetary policy makers are fully committed to acting as needed to withdraw on a timely basis the extraordinary support now being provided to the economy, and we are confident in our ability to do so ... I believe that we are well-equipped to make those judgments appropriately."
Basically, Mr. Bernanke was saying: "Trust us."
That's just not good enough.
While the public may be most concerned about the general economy and the job market, investors are beginning to look past the
recession to its aftermath, in particular to the longer-term effects of the easy money policies of the Fed in recent months and the unprecedented level of federal spending.
The Fed has lost credibility with the financial markets because its crystal ball has been cloudy in the past 15 years. It failed to foresee the Internet bubble and withdraw the monetary stimulus that fueled it until it was too late.
Likewise, it failed to see that easy money was fueling the housing bubble until it basically lost control of long-term interest rates. Then, as the housing bubble burst, the Fed's first steps to fend off this
recession were too small and too late.
As a result, there is skepticism that the Fed's governors will recognize incipient inflation soon enough to head it off successfully, and even if it does read the danger signals correctly, there is fear that its actions will be too weak for success.
Mr. Bernanke and his colleagues should spell out unambiguously — and soon — the signals they will be watching to determine if inflation is a threat, the weapons they are prepared to deploy to prevent its grip, and how those weapons will work.
That will be more relevant to the financial markets than another rehash of how we got into this economic mess and what the government has done about it.
That's the past; let's focus on the dangers of the future.
