Ben Bernanke listens to his critics.
The Federal Reserve chairman's speech Monday to the Economic Club of Indiana in Indianapolis is a response to the firebombs that are routinely hurled at the Fed.
Mr. Bernanke takes a stand against the most common criticism of Fed policy: that all the central bank's money printing will cause inflation.
Fair question, Mr. Bernanke says. But the Fed's quantitative easing policies don't actually flood the economy with billions in cash, he notes. The Fed actually creates electronic credits at banks to buy financial assets, and the banks have been hoarding these credits rather than pumping out loans. The money supply hasn't grown that quickly, Mr. Bernanke said.
"For controlling inflation, the key question is whether the Federal Reserve has the policy tools to tighten monetary conditions at the appropriate time so as to prevent the emergence of inflationary pressures down the road," Mr. Bernanke said. "I'm confident that we have the necessary tools to withdraw policy accommodation when needed, and that we can do so in a way that allows us to shrink our balance sheet in a deliberate and orderly way."
One might assume Mr. Bernanke would say that. More interesting was his decision to take on the more abstract criticism that the Fed's policies are letting the fiscal policy makers off the hook.
The new book on former Fed chairman Paul Volcker by New York University professor William Silber suggests the Reagan administration finally was forced to raise taxes to reduce the deficit because Mr. Volcker jacked up interest rates. With that in mind, many of Mr. Bernanke's critics would tell you that the current Fed chief is no Paul Volcker.
Mr. Bernanke apparently takes great exception to the notion that he should play games with Congress and the White House. "Using monetary policy to try to influence the political debate on the budget would be highly inappropriate," he said Monday.
He also questioned whether such a strategy would work. Higher interest rates now would weaken the economy, widening the gap between spending and revenue. In effect, Mr. Bernanke is warning his critics to consider the case of Greece: higher interest rates might prod politicians to act more swiftly, but the crisis also could accelerate. The policy makers could be unable to keep up.
"Would such a step lead to better fiscal outcomes?" Mr. Bernanke asked. "It seems likely that a significant widening of the deficit – which would make the needed fiscal actions even more difficult and painful – would worsen rather than improve the prospects for a comprehensive solution."