Chairman Ben Bernanke disabused us of that notion this week when he delivered the Fed’s semiannual monetary policy report to Congress.
“We do not see the potential costs of the increased risk- taking in some financial markets as outweighing the benefits of promoting a stronger economic recovery and more-rapid job creation,” Bernanke said in prepared testimony. The Fed will continue its $85-billion-a-month asset purchases, he said, “until it observes a substantial improvement in the outlook for the labor market in a context of price stability.”
Bernanke did a good job of outlining, and downplaying, the risks of expanding the Fed’s balance sheet, which, at $3.1 trillion, is almost four times its pre-crisis size. Along with the extended period of near-zero interest rates, large-scale asset purchases have the potential to increase the rate of inflation, encourage excessive risk-taking and financial instability, create market distortions, and, when interest rates rise, produce capital losses on the Fed’s portfolio of long-term securities.
I would add one more risk to his list: a loss of credibility as the Fed appears more willing to tolerate higher inflation in the short run in exchange for lower unemployment.