I find it very interesting that these so-called excess reserves are already coming down. Last May they were running close to $850 billion, which is an astronomical number. But in the last few weeks they’ve dropped to $700 billion. This may suggest that the economy’s animal spirits are awakening from their slumber.
My hope is that Bernanke & Co. actually uses the excess reserves as a policy variable, rather than as something to be manipulated by the interest charged for those reserves. But the bigger question for future Fed policy may be whether the government bank employs forward-looking market-price indicators to gauge future inflation and its own operations. These consist of the dollar, commodities (including gold and energy), and Treasury bond rates.
Mr. Bernanke has a poor track record here. As Alan Greenspan’s copilot in the early 2000s, Bernanke deliberately dissed the dollar and commodities in Fed meetings as potential inflation influences. So from 2002 to 2005, an over-easy Fed bubbled up housing, energy, and commodities, allowed the dollar to sink, and wound up moving the consumer price inflation rate from 1 percent to 6 percent, all of which helped sink the economy into the Great Recession.
As chronicled in the Wall Street Journal editorial pages, these Bernanke-sponsored monetary errors weren’t the result of stupidity, but of using the wrong targets -- such as the unemployment rate, resource-capacity underutilization, or the difference between actual and potential GDP. These statistical measures are highly suspect, whereas market prices are the real McCoy.
So right now, if the Fed targets the unemployment rate and the recessionary underutilization of economic resources -- as Bernanke suggested it might in his congressional hearing -- it is quite possible the central bank will repeat the very same mistakes it made in the early part of this decade.
Complicating matters, President Obama’s massive spending-and-borrowing policies -- and the tax hikes to pay for them -- will significantly reduce the economy’s ability to grow. This means that each dollar of Fed-created money becomes potentially more inflationary, just as it means unemployment will stay higher than usual.
I have no doubt that Mr. Bernanke and the Fed have the right tools to protect the consumer dollar. The question is: Do they have the wisdom?