In my career, I have never witnessed a situation like the one that exists now, when views about inflation risks have coalesced into two diametrically opposed camps. On the one hand, one group worries about the long-term inflationary implications of a seemingly endless procession of massive federal budget deficits. At the same time, others fear that economic slack and downward wage pressure are pushing inflation below rates that are considered consistent with price stability and even raising the specter of outright deflation.
The fear of higher long-term inflation reflects, to a large degree, worries about Fed monetary policy. Our array of new programs to spur the economy have pumped up our balance sheet and created a huge quantity of bank reserves in the process. Some worry that we won’t be able to shrink our balance sheet because of political pressures, and in the process we will end up monetizing the government debt. This fear is real, growing, and disruptive. That’s why it’s so important for me to say the following loud and clear: We at the Fed are and will remain fiercely independent from politics. We have the means—and we certainly have the will—to tighten policy when the time is right. In fact, by raising the interest rate that we pay on excess reserves we can tighten monetary policy even before our balance sheet shrinks. And we are, as always, steadfast in our determination to achieve both of our statutory goals of full employment and price stability.
Whether she and the Fed in general will be believed is another story.
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