The Chairman Speaks

The Lehmann Letter (SM)

Today's Boston speech by Federal Reserve Chairman Ben Bernanke (http://www.federalreserve.gov/newsevents/speech/bernanke20101015a.htm)
carried these words in its conclusion: "... (the Fed) is prepared to provide additional accommodation if needed to support the economic recovery and to return inflation over time to levels consistent with our mandate."

That means the Fed will pursue an expansionary policy in order to stimulate borrowing and spending and slightly lift inflation to levels consistent with a robust economy.

The Fed has a tough row to hoe. Additional ease can't hurt, but the economy's slack borrowing and spending have more to do with households' strained balance sheets than high interest rates. Today's rates are enticingly low, yet potential borrowers stay on the sidelines because they lack liquidity and carry too much debt.

There's an old saying: It's hard to push a string. That means the Fed has more success using high interest rates to restrain the economy (pulling back on a string), and less success using low interest rates to stimulate the economy (pushing on a string). Low interest rates used to work after a period of restraint brought on by high rates. But today's slump is due to a burst housing bubble that left household balance sheets in shambles. Further reduction of interest rates may be no more effective than pushing a string.

© 2010 Michael B. Lehmann