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Tantrum Time at the Fed?

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Jon Hilsenrath's column in the Wall Street Journal indicates that Federal Reserve officials are getting closer to additional intervention. My friend Jon has very close relationships to many of the Federal Reserve presidents, and his columns offer authoritative insights that others don't. Recently we wrote that retail sales numbers were of great concern, and employment data continue to be weak. It has been three years since the Great Recession officially ended, but the recovery has been much weaker than we would expect following such a severe downturn.

Hilsenrath suggests a number of potential actions being considered by the Central Bank: more quantitative easing, extending operation twist, lowering the Fed Funds rate, eliminating the rate paid by the Fed on deposits by member banks, or extending the forecast of near-zero rates from late 2014 thru 2015. The problem is that for all that the Fed has done, the impact has been tepid and the prospective impact is less promising. The Federal Reserve is reaching the crossroad of limited potency, and tantrums may result. We expect that the Fed's tantrums will have as much effect as anyone's. Mr. Bernanke has challenged Congress to help, to do their job, and pull their fiscal oar. So far, Congress seems to be pulling for re-election.

As I write, the yield on the 10-year Treasury note is 1.41%. It begs the question of how much additional economic activity might be stimulated by reducing the 10-year rate to 1% or 0.5%.

All the while, deficit spending continues and the national debt increases. While stimulus is intended to foster the growth necessary to achieve "escape velocity," it's not happening. Indeed most economists, including many at the Fed, acknowledge that the debt has become so large that we will have to monetize (inflate) our way out of a good deal of it. This means that economic growth alone is not sufficient to solve this problem. That "monetizing" part of the solution scares Central bankers around the world. Inflation is something that is very difficult to control if it gains traction. This is why many on the Fed like Lacker, Plosser, and Fisher think that the Fed has done enough on the liquidity front and should stop before all of that cash causes inflationary fires.

The economic contraction that was marked by the Great Recession was thwarted, but not conquered, by gobs and gobs of cash supplied by our Central Bank and others. There will likely be more stimuli from our Federal Reserve and other Central Banks in Europe and Asia. This cycle of delaying the impact of the full economic contraction in hopes of reducing it will continue. It may be that all of the intervention will make a positive, quantifiable difference. If it doesn't, it will prove to have been a remarkably expensive error.