by G.I.

For the blogosphere, the most entertaining part of the Federal Reserve’s meeting today was Ben Bernanke’s defence during the press conference against Paul Krugman’s charge that he has betrayed his academic past in failing to ease more aggressively and aim for higher inflation.

That is a pity because while it was great theater, it obscured a more important revelation. Not only is Mr Bernanke still a dove, he is increasingly an isolated dove, and that isolation has significant consequences for monetary policy, the economy and the markets.

The statement released by the FOMC was largely as expected and a non-event for markets: “economic growth [will] remain moderate over coming quarters and then … pick up gradually,” inflation will fall from its temporarily elevated levels to 2% or lower, and the Fed expects to keep interest rates “at exceptionally low levels … at least through late 2014.”

The projections released along with the statement were far more interesting. FOMC members reduced their forecasts for the unemployment rate, and nudged up the outlook for inflation. That hawkish combination was made doubly so by the fact that just four of the 17 FOMC members think the Fed should start tightening after 2014, down from six in January.

The hawkish impression was reinforced by Mr Bernanke’s defence against Mr Krugman (whose name never came up but whose New York Times Magazine article, judging by the questions, had been read by all the reporters in the room). Mr Bernanke flatly rejected the accusation that he is acting inconsistently from the advice he gave the Bank of Japan over a decade ago, noting that Japan was in deflation then and America is not now, in no small part thanks to the aggressively easy monetary policy the Fed has pursued. He went on to argue that deliberately targeting higher inflation as Mr Krugman advises (because it would reduce real interest rates) in pursuit of a slightly faster fall in unemployment was a “reckless” tradeoff. Judging from my twitter feed, Mr Krugman’s partisans outnumber Mr Bernanke’s by a hefty margin. Mr Krugman himself dismissed Mr Bernanke’s response as “Disappointing stuff.”

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By Bill Bonner

“Monetary policy cannot fulfill each and every market expectation.”

So said the head of the Bundesbank, Jens Weidmann.

Why not, investors want to know.

Mr. Weidmann was talking to The Wall Street Journal. He was explaining why Germany was sticking to its guns. They don’t use that expression in Germany. But you know what he meant.

“The crisis can be solved only by embarking on often-painful structural reforms,” he insisted. “If policy makers think they can avoid this they will try to.”

Mr. Weidmann is talking about the present. He is also describing the future. In the old world there is a backlash growing against the Germans and their financial guns. Austerity doesn’t seem to work. Countries try it. They cut spending. They fire people. They get nothing from it. Their budgets are still far out of balance, with deficits way above the 3% limit demanded by the European Union. Unemployment goes up. GDP goes down. Unhappy mobs start breaking windows. Why bother?

Look what is happening in Britain, for example. The Telegraph reports:

The unexpected 0.2pc contraction in UK growth followed a 0.3pc fall in gross domestic product (GDP) in the fourth quarter of 2011, signalling a technical recession and Britain’s first double-dip since 1975.

Economists had expected the Office for National Statistics data to show the economy grew by 0.1pc between January and March.

The Prime Minister said the figure was “very, very disappointing” but added that that it would be “absolute folly” to change course and jeopardise Britain’s low borrowing rates. He told Parliament:

“We inherited from [Labour] a budget deficit of 11pc. That is bigger than Greece, bigger than Spain, bigger than Portugal […] The one thing we mustn’t do is abandon spending and deficit reduction plans, because the solution to a debt crisis cannot be more debt.”

Of course, you might look at these facts and conclude that they are not trying hard enough. Instead of making smallish cuts…why not make big ones? Why not actually balance government budgets so that they can tell German central bankers to drop dead?

Everyone agrees that that would be too radical. It would invite “social upheaval.” Apparently, actually living within your means is no longer politically or socially acceptable. You have to live beyond your means… The only question is ‘who will pay for it?’ The answers to that question are not easy. When debt levels were low, the answer was probably ‘future generations of taxpayers.’ At today’s debt levels it is unlikely that the debt will ever reach future generations. And with so much of the debt now being taken up by the central bank the burden shifts, from lenders to borrowers, taxpayers and consumers. Good debts may fall on debtors…even those who are not even born yet. But bad debt and inflation float down like leaves…blown by the winds…and eventually dropping down on innocent passers-by.

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