What Bernanke Hasn't Answered Yet

Ben Bernanke has taken to the Congress and the media to try and assure the country that when the time comes he will do all that he can to avoid inflation. These steps include: raising the Fed Funds Rate, reduce their balance sheets by about $200 billion, increasing the interest the Fed pays on reserve, and fourth they will sell back some of the securities they have bought, both recently and in the long term. All of these would be effective tools in curbing potential and likely upcoming inflation.

Yet, Bernanke still hasn't explained the conundrum he faces. Here is how Bernanke views the intermediate future of the U.S. economy.

Federal Reserve Chairman Ben Bernanke on Tuesday said the outlook for the long-suffering U.S. economy appears to be improving and the U.S. central bank was carefully reviewing ways to withdraw its massive monetary policy stimulus when conditions permit.

Bernanke repeated the Fed's forecast that the economy should start growing again in the second half of this year, but he warned growth would be slight, leading to higher unemployment.

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The nation's unemployment rate climbed to a 26-year high of 9.5 percent in June. The Fed says it could rise as high as 10.1 percent this year, and stay elevated into 2011. The post-World War II high was 10.8 percent at the end of 1982, when the country had suffered through a severe recession.

Bernanke predicts that GDP will again grow before the end of the year while unemployment will rise through at least the end of 2010, and even longer. Let's assume for a minute that his predictions are correct. As the economy begins to grow, so to will inflation grow. There's at least a year lag between economic growth and job growth. Yet, inflation fears are real and significant.

So, that means that inflation will also begin to grow sometime in 2010. By Bernanke's own words, that would mean that sometime in 2010 he would began to implement some or all of the techniques that he has outlined. All of these techniques would infact tame inflation. They would also be contractionary.

By Bernanke's own words, he will begin sometime in 2010 to raise the Fed Funds rates. Sell back securities, and raise rates paid to banks for parking their money. That will increase borrowing rates for both banks and consumers. It will also raise rates for banks to park their money. That is a combination of contrationary activities all at once.

The only thing he's quantified is the reduction in balance sheets, $200 billion, but we can all bet that these activities will be significant. We know this because Bernanke has addressed these moves well in advance. That's how serious he takes potential inflation. But if he's making borrowing more difficult, and encouraging banks to keep their money idle, isn't he significantly contracting the economy just as it's slowly recovering? If he's doing that, isn't he fixing inflation by throwing the economy right back into a recession?

So far, Bernanke hasn't squared these two issues. If he sees a slow recovery and at least a year lag in unemployment, and yet he also sees serious inflation ahead, then all problems won't be solved at once. All that Bernanke showed with both his current testimonly and his oped is that he's in an untennable position. No matter what he does he will create another economic calamity with his actions.