Forget for a moment the lagging economic indicators, such as employment, and realize that conditions are better than they were eight months ago.
Disaster has not occurred.
I’m not ready to hang a “Mission Accomplished” banner outside the Federal Reserve, because the job is not done and the bill has not come due.
Lately, there’s been a lot of handwringing over how the Fed will exit from all the rescue efforts it’s undertaken. Most Fed officials haven’t touched the topic, because they want to stress their pursuit of policies that encourage economic growth. That can feed the nightmares of the Inflation Generation and spur lively debates among camps of economists.
So James Bullard, president of the St. Louis Fed, deserves credit for coming to Philadelphia yesterday to talk about those “exit strategies.”
Bullard told the nonprofit Global Interdependence Center the Fed’s liquidity programs, such as those for the commercial paper market and foreign currency swaps with foreign central banks, should spur no worries because there are signs that use of them is decreasing.
What is of concern is how the Fed is going to unwind the $1.75 trillion asset-purchase programs it launched earlier this year. It’s been buying the agency debt of Fannie Mae and Freddie Mac, and longer dated Treasuries through “reserve creation,” Bullard said. You know it better by the phrase “printing money.”
The central banker’s handbook says that if you permanently double the money supply, you will eventually double the price level. Should the Fed do nothing, in the near term inflation would remain benign. But, in a video on the St. Louis Fed Web site, Bullard explains that 10 years out, inflation could be expected to run at 7 percent a year.
The challenge for the Fed is not only when to sell those assets before inflation takes hold, but also to manage investor expectations of inflation. Expectations are powerful forces. If lots of investors think inflation is going to be higher in the future, they push up long-term interest rates today.
Bullard’s speech is a sign that the Fed takes those expectations as seriously as that mountain of mortgage-backed securities growing in its vault.