Tough Decisions For The Fed

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It's your problem, Bernanke tells Congress

The question of the day is: Who is going to shut off the spigot? Clearly it's not the Fed, at least not Bernanke, as noted above. Indeed, Bernanke tells Congress, It's your problem.

Congress and the people who elected it must decide how much government they want to afford, Bernanke said. Stating the obvious, he went on to say: "Crucially, whatever size of government is chosen, tax rates must ultimately be set at a level sufficient to achieve an appropriate balance of spending and revenues in the long run."

Unfortunately, Congress and the people have seldom gotten the balance right. We want the benefits of a large government without paying the costs, just as we wanted a loftier personal living standard than our income could support.

For its part, the Fed also faces having to make some tough choices. The U.S. central bank has lowered interest rates substantially and has expanded its balance sheet by about $1.2 trillion, effectively flooding the banking system with cash to keep the economy from collapse.

Everyone knows this and accepts it in principle -- but in practice, it will come down to knowing when to let go. It will require a deft hand and a dollop of good luck to keep the economy from crashing back to the ground or, conversely, from soaring like Icarus and burning up with inflation.

Sadly, the Fed's near-impossible task is child's play compared with the problem faced by the Obama administration, the Congress and the people.

Inquiring minds are reading An Economy at Risk: The Tough Decisions Ahead by Thomas Hoenig, President, Federal Reserve bank of Kansas City. Here are a few quotes.

"In the long run we are all dead but our children will be left to pick up the tab".

"In our efforts to fix the oversight process for our financial system, we should not misdiagnose the patient. Unfortunately, I'm afraid we are witnessing some regulatory malpractice now. The emphasis on reform at the moment is to change the structure of the regulatory system rather than address the fundamental weakness of that system."

"Capitalism is a process of success, failure and renewal, and for it to work properly, institutions must be allowed to fail, no matter their size or political influence."

"Over the past two decades, The US has created for itself a set of economic imbalances that, in my judgment, have significantly increased uncertainty and placed economic growth at risk for future generations of Americans".

"Starting from where we are today, it is clear that interest rates must rise."

"I suspect there will be considerable pressure on the central bank to 'help out' in easing this adjustment process by keeping interest rates low for an extended period. This happens because people often confuse the establishment of low interest rates - and therefore the creation of money - with the creation of wealth".