Charlie Plosser, president of the Philadelphia Federal Reserve Bank, warned this week about the risks of inflation, overly aggressive interest-rate cuts and further damage being done to the Fed's credibility. I agree with Plosser.
I say this as a supporter of the "shock and awe" Fed policies that brought the fed funds target rate down from 5.25 percent to its present 3 percent. These aggressive actions were necessary, and they've paid off. The target rate is now properly below the 10-year bond yield, while the Treasury curve is upward sloping for the first time in nearly 20 months. The overly tight money period of 2006-07 has finally come to an end. And even though in its aftermath the economy could skip into mild recession, this is a positive, watershed event.
Most economists ignore the fact that the subprime credit crisis, along with the extraordinary downturn in housing construction and home prices, is largely the result of the Fed's massive tightening move that lifted the funds rate above 5 percent in the first place. Fed Chair Ben Bernanke inherited this bucket of smelly molasses from his predecessor, Alan Greenspan. In straightening the situation out, Bernanke has opened the door to a rapid economic recovery. It's a signal achievement for the former Princeton professor.
Bernanke has taken a lot of criticism in the last year, and I think much of it is undeserved. Wall Street claims that he's an isolated academic, unaware of the real-world difficulties of sagging capital markets, slumping stock prices and slowing growth. But he moved aggressively once he saw the credit problem develop last summer. And new information obtained under the Freedom of Information Act reveals how he has been meeting with leaders in business, finance and government all along.
He has talked with John Chambers, the CEO of Cisco Systems, Sam Palmisano, the head of IBM, JPMorgan chief Jamie Dimon, former Senate banking head Phil Gramm, and international central bankers Jean Claude Trichet and Mervyn King. The street was wrong about Bernanke. He's been on top of the situation. He took remedial action, and the economy will be the beneficiary faster than people think.
But here's his next challenge. Bernanke needs to end the stop-and-go policies he inherited from his predecessor. Greenspan became a supreme monetary tinkerer in his final years, putting the Fed's interest rate and monetary levers in constant overdrive. Go. Stop. Go. Stop. This Keynesian central planning has damaged the Fed's credibility. It has weakened the dollar. Entrepreneurs and investors can't possibly plan ahead when interest rates bob up and down like yo-yos.