What Did Ben Bernanke Say?

Commentators are hyperventilating about the Fed Chairman's apparently contradictory statements about the potentially inflationary impacts of QE2. Since Mr. Bernanke is now a full-fledged political figure, contradictory statements and a lack of clarity are basic tools in the sound bite arsenal.

He said that the effect of QE2 was not to increase currency in circulation, and therefore there was no need to worry about inflationary expectations increasing. This may be correct, but it is off the point and misleading. The unprecedented expansion of the Fed's balance sheet has not increased the amount of currency in the hands of the nonbank public. True enough.

However, the truth is that nobody really knows the effect of such a huge expansion of the monetary base on inflationary expectations. Historically, the impacts of other such expansions in foreign countries is mixed. Generally, if the expansion is viewed as temporary, and market participants believe that imbalances will be redressed in our case by fiscal policy restraints and budget balancing, then the expansion will serve its limited purpose and not have an inflationary effect. However, there is no reason to believe that our politicians will show any fiscal leadership or restraint. Where is the experience to show that they can rise to the occasion?

If the monetary base expansion is viewed as permanent, then it will almost certainly lead to higher inflationary expectations, and we will be in uncharted territory..again.