Wednesday, July 21, 2010

Evidence that Bernanke is Clueless (and a Mad Scientist)

In testimony today before the Senate banking committee, Ben Bernanke stated:

Monetary policy is currently very stimulative. If the recovery seems to be faltering, then we at least need to review our options. We have not fully done that review and we need to think about possibilities. But broadly speaking, there are a number of things we can consider and look at. One would be further changes or modifications to our language or framework, describing how we intend to change interest rates over time, giving more information about that. We could lower the interest rate we pay on reserves, which is currently one fourth of one percent. The third will have to do with changes in our balance sheet and that would involve not either letting securities run off as they are currently or even making additional purchases. We have not come to the point where we can tell you precisely what the leading options are. Clearly each of these options has got drawbacks, potential costs. So we are going to continue to monitor the economy closely and continue to evaluate the alternatives that we have, recognizing that the policy is already stimulative. We still have options, but they are not going to be conventional options, so we need to look at them carefully and make sure we are comfortable with any step that we take.
Monetary policy is not very stimulative, if you look at money supply growth. Six month annualized  M2 growth is at 1.6% (Three month annualized growth is  showing a little expansion at 4.0%)

Bernanke is falling into the trap that many are, i.e. they believe low interest rates in and of themselves are an indication of monetary stimulus. With the Fed Funds rate below the rate paid on excess reserves, money is going to pile up in excess reserves (as it has), where it does not enter the economic system.

Bernanke is correct when he says the Fed could lower the interest rate on reserves to put that money into the system. But, the fact that he is reluctant to identify that as the main method to "stimulate" the economy and he suggests that adding assets to the balance sheet could be another method is indicative of how unsure he is of all the new "tools" he has added to manipulate the money supply. He knows these "tools", such as paying interest on reserves, have not been tested over time and that it is quite possible one of these "tools" could blow up in his face.

If he was sure of how all his new "tools" would interplay, he would be much more confident and say something like, "If we need to add money to the system, we can simply lower the rate on excess reserves and more money will enter the system."

Bottom line: It is really quite incredible that, in the middle of a financial and economic crisis, Bernanke added new tools by which to manipulate the money supply, when the old tools, controlling: the Fed funds rate, the discount rate and the reserve requirement, worked just fine for all other Fed chairman.  This is nothing but evidence of a mad scientist at the helm of the money supply.

Right now the money supply is very tight and he doesn't appear to realize it. One wonders if this also means that  at some point, if he does something that creates huge amounts of new money, he may not realize the loose policy he is conducting and that price inflation then goes completely out of control. With a mad scientist, you just don' t know for sure what is going to happen, but stability is the one thing you shouldn't expect.

(Thanks to Matt Makinson for the Bernanke quote)


  1. Rock and a hard place.

  2. Where does the Fed get the money to pay the interest? By selling assets or by printing money (changing numbers on a ledger)?