While America is facing the limits of fiscal policy, monetary policy can do more, as Federal Reserve Chairman Ben Bernanke detailed in a recent speech in Jackson Hole, Wyoming. With credit markets impaired, the Fed could buy more government bonds or private-sector debt. Bernanke also noted the possibility of temporarily raising the Fed’s medium-term inflation target (a policy that I suggested in this column in December 2008).Two things:
Given the massive deleveraging of public- and private-sector debt that lies ahead, and my continuing cynicism about the US political and legal system’s capacity to facilitate workouts, two or three years of slightly elevated inflation strikes me as the best of many very bad options, and far preferable to deflation.
- I don't agree that we're "facing the limits of fiscal policy" and, more importantly, the bond markets don't either - the yield on 10-year Treasury bonds is 2.58, indicating that if the US wants to borrow more, it will have no problem finding willing lenders. However, it does seem that our political system has reached the limit of what it is able to do.
- In last week's speech, Bernanke did "note the possibility" of raising the Fed's implicit inflation target, and then he went on to clearly rule it out (see previous post).