The Fed’s Interest Rate Gamble

The Fed’s very accommodating policies over the Bernanke era seem to be setting us up for inflation down the road.  To the general public this policy appears as low interest rates.  Low interest rates are produced by increases in the monetary base, which will lead to inflation as the economy recovers, unless the monetary base is contracted.

The problem is, every strategy to contract the monetary base would result in higher interest rates, something Bernanke doesn’t want.  So, expect inflation ahead.  While Bernanke says he has an “exit strategy,” I don’t see a viable one, and Bernanke hasn’t offered any details on his “exit strategy” plans.

So, I found this article interesting, because it appears there is some dissent even among the Fed’s highest-level policy makers.  The dissenters are led by Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, who argues the Fed needs to raise interest rates (which will limit the growth of the monetary base), and accelerate its sale of the mortgage-backed securities it has bought over the past few years.  I agree with Mr. Hoenig.

Dealing with the current recession, Mr. Bernanke, who is one of the world’s leading authorities on the Great Depression, says he understands the mistakes the Fed made during the Depression, which increased the Depression’s severity and length, and vows that we won’t make the same mistakes this time.  It does appear, however, that we will make different mistakes.

Randall G. Holcombe is Research Fellow at the Independent Institute and DeVoe Moore Professor of Economics at Florida State University. His Independent books include Housing America: Building Out of a Crisis (edited with Benjamin Powell); and Writing Off Ideas: Taxation, Foundations, and Philanthropy in America .
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