Bernanke's Dilemma

When a country’s politicians can’t get their economic policies right, what’s a central banker to do?  Though central banks are supposed to control inflation, that’s not always their only job.  The Federal Reserve Act, for example, gives America’s central bank a mandate of “maximum employment, stable prices, and moderate long-term interest rates.”  So when Congress drops the ball, the Fed has to pick it up.

That’s the situation facing Ben Bernanke, the chairman of the Fed’s board of governors.  In the midst of one of the worst economic downturns in the nation’s history, Congress has inexplicably decided to cut spending – a sure-fire way to take the air out of the economy’s sails.

Typically, the only countries that have to cut spending in a recession are those that have lost the faith of credit markets.  They can’t pay their debts, and they need to show investors some serious belt-tightening in order to regain the ability to borrow.  The United States does not have this problem.  Despite the downgrade of its debt by Standard and Poor’s, the Treasury has no trouble at all borrowing as much as it wants.  In fact, the interest rates the Treasury has to pay these days are among the lowest in history.  No one is thinking of turning off the taps.

So if Congress is acting perversely, what’s a central banker to do?  Last week my colleagues at New York University’s Stern School of Business hosted a lecture by the governor of the Reserve Bank of India, Duvvuri Subbarao, in which he openly sympathized with Bernanke’s plight.  Even if Congress has more effective tools for maximizing employment, Subbarao said, the law states that Bernanke can’t sit on the sidelines.  Flooding the economy with money is all Bernanke can do.

Of course, floods of money can have bad effects, too.  Earlier this week the Bank of England, whose mandate is to maintain inflation near a target set by the British government, pumped an extra £75 million into the economy.  The bank’s governor, Mervyn King, apologized to Brits on fixed incomes for reducing interest rates and potentially inflating away their savings.  In response, the actress Joan Collins tweeted, “75 million pounds!! What does the Bank of England REALLY think this will do for the hard working tax payer & pensioner? Do they care?”

Apparently they do.  “This is the most serious financial crisis we've seen at least since the 1930s, if not ever,” King said on Britain’s Sky News.  “We're having to deal with very unusual circumstances and to act calmly and do the right thing.”  One of the very unusual circumstances is that the British government, like Congress, has been slashing spending.  Again, did the Brits have to make these painful sacrifices in order to show the markets that they were creditworthy?  No – their credit rating is still AAA, better than that of the United States!

King and Bernanke are the victims of politicians’ faulty policy choices.  They only have blunt instruments for stimulating the economy, and they’re being forced to use them.  So spare a thought for your friendly neighborhood central banker – he’s trying to clean up a mess that, at least recently, is not of his making.
Related Articles

A controversial theory claims past, present, and future exist at the same time

Our experience of time may be blinding us to its true nature, say scientists.

Back to the Future.
Surprising Science
  • Time may not be passing at all, says the Block Universe Theory.
  • Time travel may be possible.
  • Your perception of time is likely relative to you and limited.
Keep reading Show less

Six disastrous encounters with the world’s most hostile uncontacted tribe

From questionable shipwrecks to outright attacks, they clearly don't want to be bothered.

Culture & Religion
  • Many have tried to contact the Sentinelese, to write about them, or otherwise.
  • But the inhabitants of the 23 square mile island in the Bay of Bengal don't want anything to do with the outside world.
  • Their numbers are unknown, but either 40 or 500 remain.
Keep reading Show less

Found: second draft of Galileo's argument for a heliocentric model

At least he wasn't burned at the stake, right?

The original letter in which Galileo argued against the doctrine of the Roman Catholic Church has been rediscovered in London. Image credit: The Royal Society
Surprising Science
  • The letter suggests Galileo censored himself a bit in order to fly more under the radar. It didn't work, though.
  • The Royal Society Journal will publish the variants of the letters shortly, and scholars will begin to analyze the results.
  • The letter was in obscurity for hundreds of years in Royal Society Library in London.
Keep reading Show less