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Bernanke’s Bind: Ignore Inflation or Risk Killing the ‘Recovery’?

Aaron Task
Daily Ticker

As you've probably heard by now, this is shaping up to be a landmark week for the Fed, which holds a two-day policy meeting starting Tuesday.

In addition to Ben Bernanke's first-ever press conference on Wednesday, the fate of the Fed's quantitative easing program is likely be decided at this week's FOMC meeting.

The Fed's $600 billion QE2 program is widely expected to end on June 30, as originally scheduled. Given widespread concerns about inflation and some vocal opposition both in Congress and within the Fed, it seems highly unlikely the Fed will announce QE3 or any other type of new stimulus program this week.

But letting QE2 expire is not the same as Fed tightening, or even a bias toward tightening. "The Fed will almost certainly stick with its current policies, but may lay the groundwork for its inevitable push toward tighter rather than consistently easier policies," writes Dennis Gartman of The Gartman Letter. "Where the ECB, the Bank of Canada, the People's Bank of China, the Reserve Banks of Australia and New Zealand shall all err upon the side of tighter, disinflationary policies, the Fed will continue a while longer with holding the Fed funds rate effectively at zero."

For all the talk about inflation and concern about the central bank's credibility, the Fed is also keenly aware of the risks of withdrawing its support for the economy, much less actually raising rates.

In addition to stubbornly high unemployment and a weakening housing market (today's dead-cat bounce in new home sales notwithstanding), "several recent economic indicators appear to be flashing yellow warning signs of a potential reversal in the U.S. business cycle," writes Bloomberg economist Richard Yaramone.

Yaramone cites a "definitive downward turn" in leading economic indicators, including the Conference Board's Index of LEI, the Philadel­phia Fed's Business Outlook Survey and concerns on quarterly conference calls about commodity price inflation and supply chain disruptions after Japan's devastating earthquake and tsunami.

Of course, the Fed's easy-money policies have contributed to commodity price inflation — whether Bernanke admits it or not — but most economists agree it's a mistake to raise rates in the face of rising energy prices, as the ECB has done.

Judging by his public comments to date, as well as those of key lieutenants Janet Yellen and William Dudley, expect Bernanke to stay the easy money course unless and until the financial markets revolt.

By keeping rates so long for so long, Bernanke has gotten the economy and the financial markets addicted to easy money, putting himself in a bind from which Houdini himself might have trouble escaping, as Henry and I discuss in the accompanying clip.

Aaron Task is the host of The Daily Ticker. You can follow him on Twitter at @atask or email him at altask@yahoo.com

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