Out of Options at the Fed

Fed Chairman Ben Bernanke says the economy is on the verge of another recession—“close to faltering” was his euphuism of choice in his testimony to Congress Tuesday—and there only so much the Federal Reserve can do about it.

For once, he is mostly right.

Bernanke has already cut short term interest rates almost to zero; he has bought up a lot of government bonds under another euphemism—“quantitative easing”—and he has been begin exchanging short-term debt for longer-term debt, as a way of locking in low interest rates. This is considered heretical in some financial circles, and several members of the Fed’s own policy-setting Open Market Committee fault the Fed chair for courting inflation.

The bigger problem, of course, is deflation. A little more inflation wouldn’t hurt since it might help levitate housing prices and reduce the burden of past debt.

Bernanke could intervene even more aggressively to lock in low interest rates on long-term government debt. He could take a harder line on all the speculative activities being pursued by big Wall Street banks, at the expense to the lower-yield business of making ordinary loans. He could work with other regulators to make life a little easier for community banks, which are suffering the wrath of regulators as their small-town customers have trouble paying loans on time. (The Fed has waived the rules for Wall Street, but it’s business as usual in heartland America.)

That said, the fact is that the Fed is almost out of tricks. In a steep deflation, loose monetary policy by itself can’t produce a recovery.

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