With Inflation Low and Unemployment High, Will The Fed Step On The Gas?

Federal Reserve Chairman Ben Bernanke spoke today:

In sum, although economic growth will probably increase this year, we expect the unemployment rate to remain stubbornly above, and inflation to remain persistently below, the levels that Federal Reserve policymakers have judged to be consistent over the longer term with our mandate from the Congress to foster maximum employment and price stability. Under such conditions, the Federal Reserve would typically ease monetary policy by reducing the target for its short-term policy interest rate, the federal funds rate. However, the target range for the funds rate has been near zero since December 2008, and the Federal Reserve has indicated that economic conditions are likely to warrant an exceptionally low target rate for an extended period. As a result, for the past two years we have been using alternative tools to provide additional monetary accommodation.

Bernanke later says that in his view QE2 has been successful at pushing things in the right direction, a conclusion strongly supported by the ongoing correlation between inflation expectations and asset prices. Karl Smith is cheered.

I’m a bit less cheered.

The good news in the speech is that it indicates that Ben Bernanke has the same analysis of the situation that I have and that Bernanke had when talking about Japan in 2003. He thinks that in a depressed economy with lots of excess labor and low inflation that expansionary monetary policy can boost real output. My concern is that this always seems to have been the view of Ben Bernanke the economic analyst. But Ben Bernanke the politician has always been much less aggressive in what he delivers than what Ben Bernanke the analyst’s diagnosis would suggest. Is he outvoted on the FOMC? If so, he hasn’t done a very good job of communicating to the White House or Congress the need to send him some reinforcements.

My fear is that something about the political economy of the modern day “independent” central bank pushes it toward a deflationary bias. After all, it’s not just the Fed, it’s the Bank of Japan and the ECB, too.