Political Opinion: Bernanke’s Hobson’s Choice. Interest Rate Cuts that Stimulate the Economy Or Cause Runaway Inflation?

February 22, 2008 by
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Bernanke’s Hobson’s Choice. Interest Rate Cuts that Stimulate the Economy Or Cause Runaway Inflation?
The policies of the Bush Administration are coming home to roost.

Over just eight days in January, The Federal Reserve cut interest rates by 1.25 percentage points. This was the biggest one-month rate decrease in a quarter-century. Ostensibly this was to ease credit rates particularly with mortgage lenders so many people could refinance their fixed and adjustable rate mortgages and avoid default. This would help defuse the sub prime mortgage crisis. However inflation has reared its ugly head and the lenders have not dropped mortgage rates but raised lending standards requiring more creditworthy borrowers than those who need to refinance the most. In fact since the initial January cuts mortgage rates have steadily drifted upward because bankers see the threat of inflation on the horizon. The CPI increased at a 4% annual rate in December.

Now we have the spectre of stagflation, no growth or negative growth and inflation confronting the economy. We have seen this before under Ronald Reagan. Paul Volcker the chairman of the Federal Reserve at the time countered the crisis by sharply raising interest rates to stop the inflationary spiral. It resulted in the highest unemployment rates since the Great Depression. It was a bitter pill but it worked. Bernanke is not facing the same degree of inflationary pressure as Volcker. However decreasing interest rates to loosen credit, along with increasing oil prices coupled with the expenditures for the Iraqi War and the Bush tax cuts have created an explosive situation that could lead to run away in inflation.

Greensphan was able to cut interest rates to 1% after the tech bubble burst but he didn’t have to contend with inflation. His concern was deflation which is as bad as uncontrolled inflation but fortunately it never occurred.

Bernanke has only one choice, which is a Hobson’s choice, and that is to cut interest rates again to avoid a recession and hope inflation doesn’t get a foot hold on the economy.

Bernanke will Earn His Pay Over The Next Year.



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