This aura of infallibility is especially painful in the current economic situation when error seems to be the new religion of the Fed. Just to remind everyone — since so much denial has dominated the debate — the only reason that we are facing near double-digit unemployment and the worst economic calamity in 70 years is that the Fed was out to lunch in combating the housing bubble.
The Fed was apparently unable to recognize a massive and unexplained departure from a 100-year-long trend in the largest market in the world as a bubble. Even after they had just seen the stock bubble grow and implode they still could not conceive of a bubble in the housing market. Bernanke and other spokespeople for the Fed have also claimed that there was nothing that they could have done even if they did recognize the bubble.
Call this colossal error number one. This is drunkenly driving the school bus into the lane of oncoming traffic killing all aboard. In most lines of work, you would be fired immediately and barred from ever working again. For the Fed chairman this is just a bad break.
Having missed the largest financial bubble in the history of the world, Bernanke quickly moved to colossal error number two, failing to take adequate steps to counteract the downturn. While Bernanke deserves credit for being more aggressive than some of the quacks who would have just let the financial system melt down completely, his response to mass unemployment has been woefully inadequate.
The Fed should be targeting a higher rate of inflation in the 3-4 percent range. This would reduce real interest rates and debt burdens. What is the downside in this picture; inflation accelerates too much and hits 5-6 percent? How does that compare to years of excessive unemployment with millions of people unemployed or underemployed needlessly? No reasonable calculation of costs and risks would justify Bernanke’s timidity in the current circumstances.
Bernanke’s third colossal error is playing along with the deficit fervor being promoted by those seeking to gut Social Security, Medicare and other areas of social spending. The downturn has predictably led to an explosion of the deficit, as public spending had to fill the gap created by the collapse of private spending.