Bernanke's Inflation-Fighting Plans: Don't Worry, He'll Know When To Start Worrying

Brian Doherty | July 21, 2009

Lest you worry that the extra trillion bucks the Federal Reserve has pumped into the economy in the past year might mean inflation down the line, Fed Chair Ben Bernanke details some of his planned techniques for helping neutralize those bucks when the time comes. From a Reuters report:

Chief among [the Fed's inflation-busting plans] is the Fed's ability to pay interest on the reserves that banks hold at the Fed, Bernanke said. The interest rate the Fed pays on those reserves sets a floor under short-term rates.

If the Fed raises that rate, it can discourage banks from lending because banks will not want to lend money at rates lower than they can earn from the Fed, he explained.

Bernanke said the U.S. central bank also has other ways to raise short-term interest rates and limit the broad growth of money in the financial system.

For instance, it can arrange so-called reverse repurchase agreements with financial firms. The Fed would sell securities from its portfolio, taking cash out of the system, with an agreement to buy them back at a higher price at a later date.

The Fed could also offer "term deposits" similar to certificates of deposit to banks. Bank funds held at the Fed in such instruments would not be available for lending.

He also said the Treasury could issue securities and leave the funds on deposit with the Fed. Alternatively, he said the Fed could sell some of the securities it has accumulated.

He assures us, however, that the time to think about shrinking the money supply is still far in the future. Let us hope he manages to figure out when that proper time is correctly, or weep for every dollar you are stuck with.

Comments

NeonCat|7.21.09 @ 1:23PM|#

Other inflation fighting measures will include making it illegal to dig in couches looking for lost change, banks confiscating and destroying any Fed Reserve notes that are not 100% perfect and taking giant safes full of money and dumping them in the Marianas Trench.

Sean W. Malone|7.21.09 @ 1:26PM|#

Because Bernanke has such a fantastic history of knowing what's going on.

|7.21.09 @ 1:27PM|#

They've doubled the monetary supply. That will eventually halve the value of the dollar. All of his proposed gimmicks won't change that reality.

|7.21.09 @ 1:40PM|#

Let us hope he manages to figure out when that proper time is correctly

Let us further hope he has the backbone to ignore the pleas of the Realtors' Association and everybody else who tries to convince him it's "too soon" to raise rates.

I, for one, am not especially optimistic.

|7.21.09 @ 1:40PM|#

So, Bernanke is planning to crank up interest rates during a recession?

That'll do wonders for the recovery.

Or, the Treasury will just put T-bills in the Fed account and not take any money for them. Increasing the national debt without even getting the use of the money. Genius.

There is no practical way to take half, or nearly half, of the money now in circulation out of circulation. Attempting to do so will destroy liquidity, credit availability, and the real economy.

Bernanke is, simply, lying, trying to put off the day when fear of inflation really gets a grip on the markets and the economy generally.

¢|7.21.09 @ 1:42PM|#

My new hobby is projecting the date by which a mattress full of dollars won't buy a new mattress. Until I read this, I had February 2013.

The Fed would sell securities from its portfolio, taking cash out of the system, with an agreement to buy them back at a higher price at a later date.

Make that October 2012.

|7.21.09 @ 1:43PM|#

Where's the National Money Hole when you need it?

Ska|7.21.09 @ 1:57PM|#

Is that a flag painted on a wall with a glory hole cut into it?

|7.21.09 @ 2:00PM|#

Bernanke's "chief plan" for quashing inflation, is to bribe banks to keep their excess funds on reserve at the Fed, instead of using them to do what banks do: loan the funds out at interest.

To make this bribe work, he will have to pay interest at a rate at least as high as what the banks could earn if they lent the funds to someone else, or used them to buy appreciating assets (real estate, commodities, foreign bonds, etc.)

In the inflationary world that will occur after the current deflationary phase is over, prices in general will be rising at double digit rates, just like in the 1970s -- or even higher, given the massive amount of money creation that has occurred.

That means Uncle Ben will have to pay double digit interest rates, just to keep the hundreds of billions in excess reserves from flooding onto the market.

And it will be a losing proposition: once runaway inflation starts, the banks will rush to dump their dollars for stuff, just like everyone else, and Bernanke will have to beat the market with higher interest rates, creating more money even faster.

You don't put out a fire by pouring more fuel on it.

|7.21.09 @ 2:14PM|#

Anybody catch that show late last nite comparing the depression to the meltdown of 08'?
IIRC, it mentioned that Mellon(sp) raised rates in the early 30s which killed what little credit still available.

but it also blamed the mess on crony capitalism and the resulting stock market balloon.

Sean W. Malone|7.21.09 @ 2:27PM|#

The Monetarist (Milton Friedman/Chicago School) position is basically that brotherben - essentially, it centers around the Fed contracting the money supply & raising interest rates at a time when they should have either left it alone or expanded it and lowered interest rates.

I think that might explain the panic to some degree (people worried they won't have money in banks anymore) and the tightening/freezing of credit - but it doesn't explain the depression's actual causes very well, which is much better covered by Rothbard in "America's Great Depression".

|7.21.09 @ 2:56PM|#

Sean W. Malone, thanks for the tip. The last reading you suggested was very informative. I'll give the Rothbard a try as well. I found it online in its entirety. Thanks again.

President Pygmy Marmoset|7.21.09 @ 3:02PM|#

This is worrisome. We need to get control of the situation very soon.

I know -- I'll appoint an Inflation Czar! Problem solved.

|7.21.09 @ 3:24PM|#

prolefeed | July 21, 2009, 1:27pm | #

They've doubled the monetary supply. That will eventually halve the value of the dollar. All of his proposed gimmicks won't change that reality.

Nope. Not when people stop wanting to hold cash. your reality is too simplistic.

There is no practical way to take half, or nearly half, of the money now in circulation out of circulation. Attempting to do so will destroy liquidity, credit availability, and the real economy.

Actually there is - Ben won't even have to do anything. By paying interest on reserves, the money supply will contract by itself as lower demand for cash pushes money back into the fed. Of course, this will happen after he raises rates next time.

|7.21.09 @ 3:29PM|#

My handy Taylor rule function on bloomberg still shows the fed is too easy by 2.5% - although encouragingly, the trend seems to have stopped and is reverseing. maybe in 6 months, he can hike.

|7.21.09 @ 3:29PM|#

should have said "too tight"

Sean W. Malone|7.21.09 @ 3:35PM|#

NP Ben - The thing with the Friedman take is, it makes sense if you only consider the start of the problems to be the Crash in '29... But much like today, that would be foolish. The "problem" isn't that last October, the market crashed - the problem is that from 2003 onward, we were riding an unsustainable bubble created by the Fed & directed by idiotic housing policy. The bubble was never sustainable to begin with, so whatever precipitated the October collapse only has a proximal relationship to the pain we're experiencing, but can't be considered the "cause" of anything.

Rothbard covers the pre-1929 period in that book explaining what the Fed was doing at that time. Not dissimilar to what Greenspan & Bernanke were doing over the last 7-8 years.

Sean W. Malone|7.21.09 @ 3:36PM|#

I was gonna say Domo - 2.5% "too easy"? Meaning the "right" interest rate would be what... -2%? ha.

|7.21.09 @ 3:42PM|#

Sean - correct. mea culpa, but the taylor rule would suggest about -2.5% as the appropriate funds rates. Which is what is takes to get central bankers to endorse fiscal stimulus. inflation is coming - but not because of the funds rate. When it comes (probably 5-8% at the worst) it'll be because of the need to pay for fiscal waste like the stimulus - not because bernanke used the TSLF or his other programs to quantitatively ease.

Sean W. Malone|7.21.09 @ 3:56PM|#

Yeah, I think the inflation will be a lot higher than that.

Murphy makes a better case than I however: Mish Should Ditch his Deflation Fears

|7.21.09 @ 4:11PM|#

Why do you think the fed would be unable/unwilling to halt inflation with rate hikes?

|7.21.09 @ 4:18PM|#

Being a southerner, Minneapolis is far from climatically optimum (average annual temperature 45 degrees) for me.

In what sense is Minnesota a southerner?

|7.21.09 @ 4:18PM|#

Or Minneapolis?

Sean W. Malone|7.21.09 @ 5:01PM|#

First off Domo, I don't think that Rate hikes are really going to solve the inflation problem, they never really have in the past...

Secondly, and much more importantly - there is never going to be sufficient political will to pull out of the low interest rates. Low rates are popular, well liked by politicians and bankers, and high rates are hated by virtually everyone except people who might actually care about fiscal responsibility. Easier to keep inflation high, continually pumping more taxable money into the economy and skim it off the top to pay for other "popular" programs and more pork.

Frankly, as the investors say "go with the trend"... and the trend is that since the creation of the Fed the dollar is worth 4% of what it was. There's a reason for that.

And since nothing else has fundamentally changed even slightly - I'm going to go with this: The Trend

Sean W. Malone|7.21.09 @ 5:04PM|#

PS, let me just add - the Fed will very likely raise rates some eventually, but given who's running the show right now, they could push (as some in Europe have) for negative rates, further exacerbating the inflation problem.

Call me pessimistic if you wish, but we're now on the hook for $23.7 Trillion in liabilities from TARP/bailouts... and some $90 trillion in general government... So where's that money coming from? If history is any guide, most of it will wind up just being printed.

mark|7.21.09 @ 6:25PM|#

If history is any guide, most of it will wind up just being printed.

Ah, wealth destruction. The suffering, the horror, but also, the surviving! Plastic cups reused rather than thrown away, couples getting out the 18-piece cookware set for the first time. Probably to sell 16 or 17 pieces but then, to cook something! Maybe. Let's see... bands of industrious gangs roaming the countryside for destruction and then harvesting for scrap metal. Unsold houses with scores of unlucky bastards living in them. Gah! I don't want to be like them, I have to get back to work!

Oh yeah, and locking gas caps.

|7.21.09 @ 6:25PM|#

Inflation is not a necessary consequence of massive government borrowing and spending. Borrowing and spending is bad, but not because it's inflationary; it's bad because it increases the amount of wealth taken from those who earned it and spent by those with no accountability or incentive to spend it gainfully.

Inflation is always and everywhere a monetary phenomenon. Bernanke is absolutely right - the Fed can create as much or as little inflation as they want, using the tools currently at their disposal. I see no reason to think they'll allow inflation to be anything other than low and stable - Bernanke has consistently said, both before and during his tenure on the Fed, that doing exactly that should be the Fed's primary mission.

And per Sean W. Malone: "So where's that money coming from?" The answer is that it's coming from future taxpayers, same as all government deficit spending. It's more than we've ever seen before, but that doesn't change the basic nature of how government funding works. The government will take some awfully large percentage of the wealth and prosperity earned by productive people, always, forever. The recent unprecedented boondogles just raise the percentage.

Sean W. Malone|7.21.09 @ 6:49PM|#

The basic nature of how government funding works since 1913 and especially since 1973 is to PRINT the money. Again, pointing to CPI data for forever.

Sean W. Malone|7.21.09 @ 6:50PM|#

we'll get taxed, sure, but there's a limit to that... there's a limit to borrowing too, partially cause of how hard it's going to be to tax later, but because of creditors... much easier to just inflate the currency - and that's exactly what they've done for decades. I see no reason they would stop now.

Sean W. Malone|7.21.09 @ 8:50PM|#

Ooh - PS... Schiff makes my point today on Bernanke's "exit strategy"

|7.21.09 @ 10:38PM|#

You youth are not old enough to remember the stagflation of the seventies, apparently; aye, it took a while to bring it under control, but it WAS brought under control... We actually have quite a few ways to combat inflation-
the tools for fighting deflation, on the other hand, are quite limited.