Long Term Inflation Forecasts Low, Despite Growth Of Fed Balance Sheet
In a speech today, Fed Chairman Ben Bernanke discusses the central bank’s policy initiatives and the impact it has on it’s balance sheet. In recent months, there has been quite a bit of discussion on the explosive growth of the Federal Reserve’s balance sheet during the financial crisis.
Finally, the expansion of the Federal Reserve’s balance sheet has raised some concerns–and led to some misconceptions–about the credit risk being taken by the Fed. I will address the issue of credit risk today. And I would also like to talk about steps that the Fed is taking to improve the transparency of its programs to the public, consistent with our obligations in a democracy.
It does seem that the Fed has taken a much smaller profile since the start of the year, perhaps to give the new administration a chance to coordinate policy goals and agree on a concerted plan of action to deal with the current crisis. That being said, the Fed today also released the minutes of it’s most recent FOMC meeting in an effort to become more transparent to the public.
The Fed has taken extraordinary steps in trying to deal with the worst financial crisis since the Great Depression. It has been estimated that the Fed has pumped in over $8 trillion in liquidity so far into the money supply which has raised concern over the increased credit risk the central bank has opened itself to as well as the prospect of inflation in the future.
Bernanke sought to calm some of those fears today, explaining that Fed’s assets are mostly short term in nature and that they can be quickly reduced as the economy normalizes. According to the recently released economic forecasts reveal that the Fed is estimating long term inflation at a modest 2%.
This is of course a far cry from estimates over the summer, commodity prices started to take a nosedive. However, a major reason for the decline in long term inflation estimates has to do with credit creation.
Although the Fed has sought to expand the monetary base of the economy, there is not the corresponding growth in credit that we would have seen in years pasts. You can think of credit creation as a multiplier of the money supply and that number has shrunk significantly since the financial crisis began.
In fact, without the Fed’s balance sheet actions, we could very well be talking about the risk of deflation right about now.
