Fed Independence?

"When the Federal Open Market Committee meets this Tuesday and Wednesday, the [Fed] will face a serious dilemma. ... To answer this question, we need to look at why long-term interest rates have risen. Here, there is good news and bad news. One cause of the rise in long-term rates is the more positive economic news of the past couple of months, particularly in financial markets. The bad news is that long-term interest rates are higher because of concerns about the deteriorating fiscal situation, with massive budget deficits expected for the indefinite future. To fund these future budget deficits, the Treasury has to sell large quantities of bonds both now and in the future, causing bond prices to fall and interest rates to rise. The increased supply of Treasury debt puts pressure on the Fed to buy it up. ... First, it might suggest that the Fed is willing to monetize Treasury debt. The Fed does not, and should not, want to make it easy for the Treasury to sell its debt and thereby be an enabler of fiscal irresponsibilty. Second, if the Fed loses its credibility to resist pressures to monetize the debt it could cause inflation expectations to shift upward, thereby leading to a serious problem down the road. ... The Fed is boxed in. The slack in the economy that is likely to persist for a very long time suggests the need for stimulative monetary policy to lower long-term interest rates through the purchase of Treasurys. The fiscal situation argues against this policy action, because it would weaken the Fed's inflation-fighting credibility. How can the Fed get out of the box and pursue the expansionary monetary policy that is needed now? The answer is that the Obama administration and Congress have to get serious about long-run fiscal sustainability. ... It needs to address exploding spending on entitlements--Social Security and particularly Medicare--which are causing future deficit projections to be so bleak", my emphasis, Frederic Mishkin (FM) at the WSJ, 22 June 2009: http://online.wsj.com/article/SB124562899626335803.html.

"Monetary authorities like Ben Bernanke who claim loftily that they will withdraw monetary easing well in time before inflation really gets a grip should be disbelieved. So should fiscal panjandrums like Treasury Secretary Tim Geithener or Chancellor of the Exchequer Alistair Darling, when they claim that the current orgy of public spending is only temporary. ... Even the most hawkish of the Fed governors, the Philadelphia Fed's Charles Plosser, talked last week only of an inflation problem that might lead to 4% inflation by 2012. He is far too low, and far too late. The recent upsurge in oil and gold prices, back above $60 and close to $1,000 respectively, indicates that inflationary forces have already taken a grip on the global economy. ... But by the end of 2009, it will be obvious to even the doziest Middle Eastern central banker that inflation in the US and Britain, at least, is running at over 5%, and is well on the way to 15% to 20%. ... The theory that the People's Bank of China, the Bank of Japan and the various Middle Eastern central banks will buy more of this rubbish in order to protect their existing holdings will at some stage become false. ... Policymakers WANT to believe that deflation is the main threat, because it justifies zero interest rates, and they WANT to believe that they can borrown 10% of GDP without adverse consequences", original capitals, my emphasis, Martin Hutchinson (MH), 26 May 2009 at: http://www.prudentbear.com/

FM is a Columbia economics professor and was a Fed governor. FM apparently does not understand accounting. The "serious problem" is not "down the road". It is now. What "inflation-fighting credibility" is FM talking about? The Fed creates inflation! "The Fed ... should not want to ... be an enabler of fiscal irresponsibility" says FM. What does FM think the Fed's real job is if not to faciliate the sale of Treasury debt?

I agree with MH.