The Fed Painted Into a Keynesian Corner

Although one sympathizes with Ben Bernanke—after all, it wasn’t his fault that Greenspan handed him an economy rigged with ticking housing and mortgage bombs—the harsh reality is that the Federal Reserve can’t create prosperity. Strip away all the pomp and glamour of “open market operations” and the like, and we’re left with the simple fact that the Fed creates money out of thin air. This power allows it to give a gentle nudge here and there to make the economy appear prosperous, but ultimately green pieces of paper (or electronic deposit entries in the Fed’s computer) don’t create real output, wealth, or prosperity.

The U.S. economy is showing many dangerous parallels to the dark days of the 1970s. During 2007, consumer price inflation was 4.1 percent, the highest it’s been in 17 years. The dollar is near record lows against the euro and a basket of foreign currencies. Gold and oil prices, expressed in dollars, have set all-time record highs in the past few months.

The solution to our current mess isn’t found in printing more U.S. dollars. That will only further fuel inflation, and—as today showed—Fed loosening isn’t even providing temporary relief anymore. There is really no other solution but to return the fed funds target rate to its proper, long-run level, and endure the recession. Cutting marginal tax rates can certainly help, but a recession is inevitable. It will be painful, as recessions always are, but it is going to happen regardless of Fed policy. The only issue is whether it will be quick and modest, or prolonged and severe. Literally throwing more money at the situation will push us towards the latter alternative.

Nothing contained in this blog is to be construed as necessarily reflecting the views of the Pacific Research Institute or as an attempt to thwart or aid the passage of any legislation.

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