Ben Bernanke's Conundrum

When Federal Reserve Chairman Ben Bernanke testified before Congress in July he spoke about the risks the US economy faces from two dangers: 1) a continued weakness in the economy and 2) increasing inflation. The conundrum Bernanke faces is this: if he employs the Fed's usual weapon against spiraling prices by increasing interest rates, that would contribute toward weakening an already faltering economy even further. But if he attempts to stimulate the weak economy by lowering interest rates, that will serve to stimulate an already uncomfortable level of inflation.

Because of the Fed's catch-22 situation, economic experts predict that the Federal Reserve will neither lower nor raise interest rates when it meets on August 5, 2008. Some of those experts are also saying that if Bernanke and crew leave interest rates unchanged on Tuesday, they are as much as admitting that the Fed is powerless to fight inflation or aide the weakening economy.


Rich Yamarone, who is the director of economic research at Argus Research, said "I think the Fed is not really part of the equation any more because of the corner they've painted themselves into."

That is some pretty strong language from Yamarone because it implies that the Fed is responsible for the nation’s current economic situation, when, in reality, a whole host of entities are to blame.

The Federal Reserve has cut the key federal funds rate seven times between September, 2007, and April, 2008, in an attempt to prevent the Nation’s economy from weakening any further. The Mortgage Mess, the housing slowdown, and the Credit Crisis that are affecting not only Wall Street, but also every mom and pop up and down Main Street, are still able to erode consumer confidence a great deal further.


But the Fed left rates alone at its meeting in June, and the federal funds rate currently sits at 2%, while the prime rate rests 300 basis points higher at 5%.

Yamarone said that the Fed’s primary concern should be inflation, implying that he would favor an increase in interest rates. His feeling is that inflation is one of the greatest threats to economic growth. If oil, food and other commodities continue soaring, that must affect future growth.

However, David Wyss, the chief economist at Standard & Poor's, believes that our current economic weakness, not inflation, should be the Federal Reserve’s first priority.

"Public enemy no. 1 is still a recession," said Wyss.

It's unimaginable for the Fed to raise interest rates in the near future. After all, the upheaval in the financial markets appears far from over and that was strongly felt to be a major contributing factor that influenced the Fed to initiate its rate cutting spree that began last September. David Wyss remarked that he believes the Fed will refrain from raising rates until next spring at the earliest.

Wyss also believes that the Fed will not cut rates again any time soon either. Wyss said that "at least a couple of months of really disastrous jobs numbers" would need to be reported before the Federal Reserve would consider cutting rates again.

If all of that is true, any change in interest rates, either up or down, will now come from market pressures, not from the Federal Reserve.

Quotes by market professionals come from CNNMoney.com

Bob Roscoe, Mortgage Marketing Associates, Minneapolis, Minnesota
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