March 28, 2012

FOR WHAT SEEMS like the umpteenth time, Federal Reserve chairman Ben S. Bernanke has offered a defense of the Fed’s unorthodox policy response to the financial crisis of 2008-09. Without those actions, the chairman told students at George Washington University on Tuesday, the world economy might have gone into a “total meltdown.”

In a way, it’s a shame that Mr. Bernanke still has to go around making that obvious point, but he’s right — both about the regrettable necessity of bailing out “too big to fail” firms and about the Fed’s subsequent zero-interest rate policy and massive purchases of Treasury bonds and mortgage-backed securities. The U.S. economy remains sluggish, despite recent signs of growth and job creation; it would be in far worse shape, however, if the Fed had not engaged in massive monetary easing.

Still, these benefits come with risks attached. Among the biggest risks is that easy money from the Fed enables banks and firms to postpone necessary restructuring — and for Congress and the White House to postpone getting the federal government’s long-term fiscal situation under control. Indeed, three of Mr. Bernanke’s own central-banker colleagues, Bank of Japan governor Masaaki Shirakawa, former European Central Bank president Jean-Claude Trichet and Jaime Carauna, general manager of the Swiss-based Bank of International Settlements, made that very point at a Federal Reserve conference in Washington last week. Bernanke-style policies “can make it easier to waste time,” Mr. Carauna warned. The Fed has bought the U.S. economy time, but if that breathing space is not used wisely, the long-term result could be inflation and higher interest rates.

Echoing those concerns, former Treasury Department official Lawrence Goodman notes in a Wall Street Journal op-ed that the Fed’s massive purchases of federal debt, which amounted to 61 percent of net Treasury issuance in 2011, are keeping interest rates artificially low — and are masking a decline in demand for Treasuries from foreigners and the U.S. private sector. Net interest payments on the federal debt actually fell between 2008 and 2011, as a share of gross domestic product, even as the deficit tripled. Mr. Goodman argues that this phenomenon gives policymakers a false sense of security about the federal government’s fiscal predicament.

Mr. Bernanke, of course, was and is well aware of this risk — but has considered it less threatening than the risk of deeper recession. Indeed, without the Fed’s policies, growth might have been even weaker, tax revenue even lower, unemployment spending even higher — and, accordingly, deficits even bigger. Mr. Bernanke’s latest view of the economy is that it is still underperforming and that there is no reason to change the Fed’s plans to keep zero interest rates through next year and into 2014.

Nevertheless, when it does come, a self-sustaining recovery will undermine the case for fiscal and monetary expansion. Both Congress and the Fed will then have to react decisively and swiftly to undo a lot of what they’ve done in the past four years. They still have time to engineer a safe exit — but perhaps not quite as much time as they think.