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Investors are worried about the solvency of many European governments and the future course of U.S. fiscal policy, especially after the protracted debate on the debt ceiling.
Now attention is focused on the Federal Open Market Committee for clarity regarding the future course of monetary policy.
But instead of providing clarity, the members of the FOMC are debating the fundamental questions of what the Fed can and should do to promote economic recovery.
The recent FOMC majority decision to keep interest rates near zero until at least mid-2013 will extend the Fed's easy monetary policy to cover a period of more than five years.
The duration and degree of monetary easing is unprecedented in the history of the U.S.
And in doing this, the Fed is underestimating the risk of higher inflation and overestimating its ability to bring the economy out of recession.
The majority view on the FOMC is flawed and carries serious downside risks to the economy. Monetary policy did not bring prosperity from the Great Depression, it did not undo the stagflation of the 1970s, it did not undo the lost decade in Japan and it will not likely create jobs now.
The Fed can — and should — conduct policy to promote financial stability, inhibit excessive risk-taking and foster low inflation.
This will do more to improve the economy than continuing monetary policy that appears to have done little to promote recovery.
Continuing easy monetary policy risks much higher inflation than the Fed acknowledges. Chairman Bernanke's speeches clearly state that he sees little risk of inflation.
He argues that high unemployment will prevent inflation from rising, and he also notes that forecasters expect low inflation to continue.
But our research, and that of others, shows that neither the unemployment rate nor inflation survey forecasts are useful predictors of inflation.
And the stagflation of the 1970s demonstrates that loose monetary policy generates high inflation even in the face of high unemployment and slack capacity.
Moreover, history shows that inflation expectations are notoriously hard to manage once the credibility of the central bank as an inflation fighter is lost.
The Volcker disinflation and the severe recessions of the early 1980s are painful reminders of the costs of reducing inflation when monetary policymakers lack credibility.
The Fed also has limited ability to grow the economy with further easy monetary policy.
Unemployment has been at or above 9% since mid-2009, despite the Fed's program of quantitative easing.
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Posted By: ThomasPTwain(150) on 8/24/2011 | 12:41 AM ET
Bernanke has no accountability. If he fails, if the middle class is destroyed by wild swings of deflation and inflation what is his punishment? How does Bernanke have skin in the game? He will feel no pain from his policies of printing money. If on Friday they announce QE3, then Bernanke is clearly insane, doing the same thing over and over and over expecting different results. With QE3 he shows he is unfit to continue his chairmanship. It is time to get back to basics.
Posted By: Ellman(1460) on 8/24/2011 | 12:22 AM ET
I don't recall another time like today, besides the Carter 1970's when the FED, the Congress, the President and all of their economic counselors seemed at a greater loss about how to right the economy. In times like these the answers are less likely to be forthcoming from arrogant, conceited elites than from those who are humble and willing to listen and learn. Never has any administration contained too little humility and too much arrogance like the Obama administration. Roulette anyone
Posted By: MCSF(235) on 8/23/2011 | 9:28 PM ET
No offense to your level of expertise but even a working class slob like myself can see the Fed can't make up for detestable fiscal policy by a communist community organizer in the whitehouse......
Posted By: jpdwn(2785) on 8/23/2011 | 7:53 PM ET
Following the ECB, it's the Lance White Fed Policy. It's time for a miracle. For those unfamiliar with Lance White, see the 1970's Rockford Files reruns.
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