Fed Chairman Ben Bernanke says the economy is on the verge of another recession -- "close to faltering" was his euphuism of choice in his testimony to Congress Tuesday -- and there only so much the Federal Reserve can do about it.
For once, he is mostly right.
Bernanke has already cut short term interest rates almost to zero; he has bought up a lot of government bonds under another euphemism -- "quantitative easing" -- and he has been begin exchanging short-term debt for longer-term debt, as a way of locking in low interest rates. This is considered heretical in some financial circles, and several members of the Fed's own policy-setting Open Market Committee fault the Fed chair for courting inflation.
The bigger problem, of course, is deflation. A little more inflation wouldn't hurt since it might help levitate housing prices and reduce the burden of past debt.
Bernanke could intervene even more aggressively to lock in low interest rates on long-term government debt. He could take a harder line on all the speculative activities being pursued by big Wall Street banks, at the expense to the lower-yield business of making ordinary loans. He could work with other regulators to make life a little easier for community banks, which are suffering the wrath of regulators as their small-town customers have trouble paying loans on time. (The Fed has waived the rules for Wall Street, but it's business as usual in heartland America.)
That said, the fact is that the Fed is almost out of tricks. In a steep deflation, loose monetary policy by itself can't produce a recovery.
If businesses don't want to borrow because consumers lack purchasing power to buy new products, even zero interest rates can't entice new investment. Lower rates can give some well-qualified homeowners a break on monthly mortgage payments, but they don't do anything for those whose homes are underwater financially.
In the 1930s, the use of cheap money alone to get the economy out of depression was rightly criticized as "pushing on a string." The economy only escaped the depression because of the massive fiscal stimulus known as World War II, a time when the government's annual deficits ran at between 25 percent and 30 percent a year. (Today, deficits of about 9 percent are giving politicians hives.)
As a byproduct of the war, a generation of Americans went back to work, government invested massively in science and technology as well as weaponry, industry was recapitalized, and consumers had money in their pockets once again.
Once the war ended, American families cashed in their war bonds, bought homes and cars, and the postwar boom was in full swing. The huge wartime debt was reduced over time as economic growth resumed.
This, of course, is the program we need today -- minus the war. Massive public investment in all of the things America's commons needs.
That view, however, defies the conventional wisdom, and the Fed chair danced around the issue. He couldn't bring himself to call for more public spending, but instead offered more euphemisms such as "fiscal sustainability," suggesting a gradual path to budget balance.
As Fed performances go, this one wasn't too bad, but Congress will need to look elsewhere for a full-throated recovery program.