Friday, August 27, 2010

How Effective Will The Fed's Measures Be?

The U.S. stock market rallied today on Ben Bernanke's announcement that the Fed will do "anything it can" to ensure recovery.

But just what can it do to "ensure recovery"? Create inflation? That's hardly a guaranteed path to prosperity as anyone in Zimbabwe would testify.

And even assuming that inflation will create prosperity, what can and will the Fed do to achieve it? It can't lower short-term interest rates any further. It could increase asset purchases, but as long as banks are unwilling to lend and/or their customers are unwilling (or unable due to a bad personal credit history), asset purchases won't do much good, especially considering the interest that the Fed is now paying on bank reserves.

Abolishing that interest or better yet making it negative would be more effective, but is the Fed really prepared to do that? I doubt it.

To be really effective in creating inflation, the Fed would have to be really unconventional, by perhaps large scale distribution of cash by helicopters or the legalization of counterfeiting. But that is not likely to happen, especially since it would require Congressional approval.

So, today's speech by Bernanke should instead be viewed as an attempt to boost confidence into the economy, without any real substance.