U.s. federal government deficits and federal reserve policy: Are there links?

Liberals and Conservatives alike are frustrated by the recuperative efforts of the U.S. government in the aftermath of the 2007-2008 financial crises.  Almost every knowledgeable commentator would concede that the various wrongdoers have gone unpunished.  Compromised and entangled firms have been bailed out, and the financial institutions that were “too big to fail” were revived via .025% Federal Reserve loans and 3% Treasury rates.  So far, the only meaningful relief for the citizenry has been the increase of the FDIC depository insurance from $100,000 to $250,000.

In a March 25, 2013 Wall Street Journal editorial, Reuven Brenner (McGill University) and Martin Fridson (Standard and Poors) picked up on Federal Reserve Chairman Ben Bernanke’s likening of his policies to the U.S. World War II monetary regime.  Bernanke had noted the success of the Fed in maintaining “a ceiling of 2.5% on long term treasury bonds for nearly a decade (1940’s)” in suggesting that interest rates could be held down even after the U.S. economy eventually revives.  But Brenner and Fridson claimed this might not work this time, because political support and patriotic fervor during the war were unique phenomena stoking U.S. Treasury bond purchases in lieu of more competitive bond rates.  Moreover, they pointed out that back then government control over the economy was exceptional including price controls and rationing.  Moreover, they noted there was no other safe place for people to put their money during this era.  They went on to mention how the pending U.S. unfunded entitlement situation, global competitiveness, and pressures for government spending, etc. do not auger well for the ability of the U.S. to pay down its’ national debt cheaply in the future. 

While it’s true that Bernanke’s pragmatic policies have not prompted inflationary pressures so far, the big question is what will happen when increased demand and money velocity do return to the U.S. economy.  Currently, the optimists think the U.S. will continue to be the world’s strongest capital magnet, and the pessimists think that uncontrolled inflation is on the horizon.