Questions For the Federal Reserve

Henrey Kaufman presents a lot of questions that the Fed is dealing with right now:

Today, with interest rates near zero and the stock market booming, increased political pressure will be put on the Fed when it begins to shift away from its current posture of quantitative easing. What will most inspire a shift toward tightening? The inflation rate? Better employment numbers or a housing recovery? That’s hard to say.

Even harder to say is how the Fed will deal with the speculative fervor now fomenting in the financial markets, i.e., the increase in the carry trade (borrowing dollars to buy assets) and the run-up of many stock and commodity prices. Will the Fed ignore these developments and wait until the economy gains full traction to raise rates?

The current economic situation suggests continued substantial monetary ease, but developments in the financial markets do not.

Closely related to the this conundrum is another one: How will the Fed reduce its bloated balance sheet—which has reached $2.2 trillion, compared with $919 billion in mid 2008? Fed holdings now include more than $1 trillion of obligations involving largely longer-dated mortgage-related securities.

Bernanke’s job is not enviable. But long-term success would be more likely if we clear the decks sooner than later. Where’s the light switch for that exit sign?

Read Kaufman’s whole piece in WSJ here.