It's Not Ben Bernanke's Fault the Economy Is Stagnant

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For years, Federal Reserve chairman Ben Bernanke has been bashed from both the left and the right for his 0% interest rate policy. The criticism from the left is built around the idea that his policies help the 1% and hurt the middle class. But the most furious condemnation comes from rightwing inflation hawks, who think Bernanke is fighting the wrong battle.

I believe years of stubbornly low inflation demonstrate how wrong the inflation hawks are. There will be a time to fight inflation, just not now. As for the critics from the left, Bernanke can lead a horse to water, but he can’t make him drink. He can't force banks to lend. He can only create conditions for them to do so, which he has, to the best of his abilities, done.

The standard monetary model tells us that when the Fed cuts rates, the result is growth and, later, inflation. Then the Fed fights inflation by raising rates and causing a contraction. It rinses and repeats every decade or so. But something is broken in the economic model. Banks these days are looking for reasons not to lend money. And this creates curious dichotomies. Banks complain they shouldn't bother to lend if the interest they earn on loans is miniscule. And lend to who, they ask – to borrowers who are already overleveraged? Banks do have a point. The risk-reward simply doesn't look good. 

Added to this, in the more partisan quarters, is the sentiment that "inflation is coming." I can see where inflation hawks are coming from: They think the system is awash with free cash. It may be, but that cash is not exactly in consumers' pockets. It's, as a result of rounds of quantitative easing, on banks' balance sheets. This is where the model starts to break down: It wasn't designed to consider who holds the cash. It always assumed the consumers did.

Additionally, the model did not factor in the overleveraged consumer or the massive overhang of household debt. So, for several years now, Wall Street, which for whatever reason (wishful thinking, perhaps?) didn't adjust its models, has been all but frozen in anticipation, breathlessly awaiting inflation. Many bond funds managers have failed in the past three years trying to capitalize on this inflation that never came. A little self-reflection on the part of banks, which are the main beneficiaries of the Fed's move to provide cash for their assets, would, like in that old Mickey Rourke movie, make them realize that the only possible source of the inflation they so eagerly seek, is themselves. Banks hold the very cash that is supposed to be spent by the consumer, but lament that there is no consumer demand. They are the very reason why Bernanke's rate-cutting exercise didn't translate into consumer spending and, therefore, inflation. By some cruel and perhaps poetic twist of fate, lending and investment arms of banks, which worked in such profitable harmony just a few years before, are their own worst enemies this time around. One arm can't invest because the other doesn't lend.

In the meantime, both politicians and Wall Street are bashing Bernanke, who, by cutting rates, simply follows the book. (Although I'm sure he is aware of that model's breakdown). So when inflation didn't come in 2009 and then didn't come in 2010 and still didn't come in 2012, it caused some head scratching for inflation hawks. Although some were so vested in their belief that inflation was coming, they were beginning, almost religiously, to see it everywhere. Every time gold or gas prices would spike, they would use it as evidence of inflation.

When oil prices rose this past summer from $80 a barrel to nearly a $100, it was hardly due to the fact that more people began driving to work, as many inflation hawks would like to believe. More likely, the demand came from hedge funds that, for the lack of yield everywhere else, had now turned to commodities. This kind of demand can hardly qualify as a sign of the economy overheating.

Bernanke was right when he ploughed through with more rate cuts, ignoring the apocalyptic forecasts. Maybe that explains the calls to audit the Fed – many think Bernanke is hiding something. Bernanke, I'm sure, would like for some bona fide, consumer demand-driven inflation to appear, because that would indicate that the economy is back on its feet and moving along. But inflation – something conservatives, ironically, also need to bash the current administration with – has been denied! In some twisted way, they want the same thing, but for different reasons. Bernanke has a correct diagnosis of the current impasse, but limited tools to deal with it.

Meanwhile, inflation hawks are looking to cure us from the disease we don't have.

Katya Grishakova left the financial industry after spending more than a decade at various Wall Street firms. She is now a board member of ACT NOW, a New York progressive organization.



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