Federal Reserve Chairman Ben Bernanke spoke yesterday before the Senate Budget Committee.
Despite great economic news last Friday, Bernanke reiterated again that he still intends to keep Fed interest rates near zero through 2014 and spoke to a range of fiscal issues.
Bernanke expressed these short-term concerns affecting U.S. economic stability:
- Payroll tax cuts set to expire this month
- Bush-era tax cuts set to expire the end of this year
- Forecasts of slow economic growth for several years
Bernanke said if the Bush-era tax cuts expire then GDP growth would slow to 1.1% next year. He also warned that continuing uncertainty in federal government economic policy is undermining confidence in the federal government’s ability to control its long term debt.
But keeping interest rates low was the centerpiece of his testimony.
Bernanke, the conservative banker, is criticized as an old fuddy-duddy who doesn’t see that the economy just needs a kick to get it going.
Critics will say he is a worry wart. They will say he is wrongly focused on the “price stability” half of the Fed’s dual mandate to the exclusion of its other more important mandate for “maximum employment”.
They’ll say price stability just controls inflation… a problem we don’t have… but jobs are what we need. They will tout inflationary spending to create jobs.
They’ll shout that keeping the interest rate low solves the wrong problem!
What Low Interest Rate?
In the movie “Die Hard with a Vengeance” New York Fed banker Philip explains the purpose of the federal reserve to super-villain Simon whose there to rob it:
Now, you were concerned about a currency exchange. We are not a commercial bank, in the normal sense. We are primarily a government central bank, that sort of thing.
“That sort of thing” means The Fed only loans to other banks, not directly to citizens or businesses. Its a bank for banks!
The money that it has to loan comes from member bank deposits. The Fed only loans money to its member banks or other central banks from those deposits.
The Fed is conceptually like regular commercial banks that loan money to citizens and businesses from deposits they get from their depositors. Its just one level up on a larger scale.
The interest The Fed charges for its loans to banks, mostly for overnight transactions, is the interest rate that Bernanke talked about before the Senate.
It takes more time for the interest rate it charges to have a noticeable economic effect.
How The Fed Loan Rate Affects the Economy
When The Fed loans to banks at a low interest rate it allows those banks to keep the interest rate they charge their citizen and business customers lower.
That makes home mortgages and other big ticket items cheaper and more affordable to ordinary citizens. That, in turn, encourages home buying and reinvigorates a depressed home mortgage market.
Lower rate business loans makes it less expensive for small businesses, the backbone of the economy, to invest and grow. Big businesses don’t need low interest cash. They already have trillions in cash reserves in their coffers. But small businesses don’t have those kinds of reserves.
The growth of small business and consumer spending powers the economy… not big business spending… not government sending.
Mr. Bernanke Goes to Washington
A central bank cannot act like other sectors of the economy that must react instantaneously to market conditions to remain competitive. It isn’t competing with anyone.
The Fed’s concern is with long term economic growth and stability. It should not knee-jerk react to things like last Friday’s good news. That is a flicker of hope that could be snuffed out next month.
So Mr. Bernanke goes to Washington. He tells lawmakers he will stay the course. Then he advises Congress what they should do for the short term.
Bernanke understands that the U.S. economy is still walking on egg shells. The economy ain’t well and won’t be for a long while. There is no room for mistakes by anyone, especially by The Fed.
The economy needs stable, reliable attention and that sure as heck isn’t gonna come from the President and the Congress. Congress won’t do anything but bicker this year. The President will just blame Congress and the rich for everything and bring no constructive ideas to the table.
Stability and consistent fiscal policy is what the U.S. economy needs more than anything else right now. Bernanke is providing that.
That is why Bernanke insisted to the Senate his intention to keep Fed interest rates near zero through 2014.
Given that needed time, through lower cost small business and consumer loans, it will promote sustainable long-term job growth with all its positive economic benefits.
Ben Bernanke is the smartest man in the room.