Bernanke has exit strategy. Will he use it?
Now, Fed Chairman Ben Bernanke has answered – sort of – in a Wall Street Journal op-ed and in congressional testimony Tuesday. The central bank "has the necessary tools to withdraw policy accommodation, when that becomes appropriate, in a smooth and timely manner," he wrote in his op-ed.
While that's reassuring, it's not what Wall Street is asking.
"His editorial is talking about the mechanisms of exiting," says Mark Rzepczynski, managing director of Lakewood Partners, a fund-management firm here in Boston. "The real [issue] is whether the Fed has the will to act."
By most counts, Mr. Bernanke has pulled off a great first act. He saved the financial system from a potentially disastrous meltdown, working effectively with first a Republican and then a Democratic White House. His bold moves to lower interest rates to near zero has eased the credit crunch and, arguably, shortened the recession.
But these times demand more central bank heroics. At some point, Bernanke will have to reverse course and undo his stimulus. The trick is getting the timing right.
If he acts too soon, he risks pushing the fragile economy back into recession (just as President Roosevelt did in the late 1930s). If he acts too late, he could stoke a firestorm of inflation.
That's a hard exercise for any Fed chairman to get right. It may be doubly so for one whose term ends in January and must be reappointed by the president.
"The market is concerned that his position is somewhat in jeopardy, and an awkward appearance today and tomorrow could do damage to the odds of him being reappointed for a full term in office," wrote Dennis Gartman, publisher of a daily investment commentary.
The question boils down to one of credibility: Will the Fed chairman, especially one who has worked so closely with the Treasury Department, start raising interest rates at the right time even when politicians on both sides of the aisle are screaming about high unemployment and struggling small businesses?
Recent US history includes examples of Fed chairmen who have stuck to their guns (notably Paul Volcker) and those who have not. No one really knows – except perhaps Bernanke himself – how he'll act when that moment of truth comes.
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