Can Bernanke Tune Out Political Pressure as the FOMC Again Ponders Policy Changes?

When U.S. Federal Reserve Chairman Ben S. Bernanke emerges from the central bank's monthly policymaking meeting at around 2:15 p.m. today (Wednesday), it's a near certainty that he'll reaffirm his pledge to keep interest rates "exceptionally low" for an "extended period" of time.

Bernanke has kept the benchmark Federal Funds rate at a record low range of 0.00%-0.25% since December 2008, and that's not likely to change as a result of today's meeting of the central bank's Federal Open Market Committee (FOMC).

At some point, however, Bernanke will have to tighten credit and raise interest rates in order to soak up all the excess liquidity and curb inflation in the U.S. economy. But the question remains: When that time comes, will Bernanke have the fortitude to do so?

There's no simple answer. And for good reason: With the country mired in its worst financial crisis in most Americans' lifetimes, the central bank's decisions now are as political in focus as they are economic.

The Fed has injected more than $2 trillion into the economy, and as the economy regains its bearings, inflation is slowly being reanimated. The central bank's so-called "exit strategy" is one of the biggest topics of conjecture from Wall Street to Main Street - and even down to K Street - since an interest-rate increase would blunt inflation and bolster the dollar, but possibly at the cost of part or all of the meandering U.S. economic recovery.

The Consumer Price Index (CPI) rose 2.7% last month from a year earlier. That's the largest gain since 2007. Producer prices, meanwhile, rose for the third straight month in December, increasing by 0.2 % and recording their largest year-over-year gain since October 2008.

That means Bernanke will have to turn his attention towards inflation and an overly expansive monetary policy sooner than he might wish. But undoing massive amounts of monetary stimulus will be difficult, especially considering the political pressure the Fed is currently facing.

To begin with, there's the question of Bernanke's reappointment as chairman of the Federal Reserve. U.S. President Barack Obama in August nominated Bernanke for a second four-year term as Fed chairman, but now more than a dozen senators have said they will oppose the Fed chairman's reappointment after his first term ends on Jan. 31. The rest of the vote counting is still in question.

"Our country is still facing an economic crisis and while I appreciate the service that Chairman Bernanke has performed as Federal Reserve chairman, I believe that he must be held accountable for many of the decisions that contributed to our financial meltdown," said U.S. Sen. John McCain, R-AZ. "Therefore, I plan to oppose Chairman Ben Bernanke's confirmation for a new term as Federal Reserve chairman."

On Monday, U.S. sens. Max Baucus, D-MT, Joseph Lieberman, I-CT., and Lindsey Graham, R-SC, said they would vote to confirm Bernanke for a second term. But even if Bernanke is confirmed, there's a question of how much autonomy the central bank will have going forward. Some analysts fear that political pressure is already bearing on the FOMC's decision-making.

"They're fortunate that they can keep a low profile right now and not do much of anything from a policy standpoint," Peter Hooper, chief economist at Deutsche Bank Securities, told The Washington Post. "The political pressure on the Fed has unequivocally increased."

Senate Majority Leader Harry Reid, for instance, justified his tepid endorsement of Bernanke's reappointment by encouraging the Fed chairman to "redouble his efforts to ensure families can access the credit they need."

Statements like that, now and in the future, could keep Bernanke and the FOMC from raising interest rates or taking unpopular - but needed - actions at critical junctures.

"I believe the FOMC would try very hard, but it's almost impossible not to think about it," Ann Owen, a former Fed economist, told Reuters. "What you don't want is the FOMC thinking about political repercussions of monetary policy."

Michael Feroli, an economist at JPMorgan Chase & Co. (NYSE: JPM) pointed out that prior to the Fed's meeting this week, there was a chance that Tom Hoenig, president of the Federal Reserve Bank of Kansas City, would object to keeping interest rates at record lows. But the political firestorm surrounding Bernanke's reappointment makes that unlikely.

"Before the Bernanke-Senate blow-up, there was a minor chance Tom Hoenig would dissent," said JPMorgan's Feroli. "In the current circumstances, no committee member would break ranks with an embattled chairman. We expect no dissents."

The good news is that most analysts don't think the Fed should take any extraordinary steps to tighten monetary policy until later this year. That renders political influence over this week's meeting relatively moot. But that doesn't mean Bernanke's credibility and authority won't be chipped away by political adversaries.

Even if Bernanke is reaffirmed, many lawmakers are still looking to strip the Fed of its bank supervisory role. Under the financial reform plan arranged by U.S. Sen. Christopher Dodd, D-CT, the Fed would lose its role as a supervisor of banks to the new Financial Institutions Regulatory Administration and its consumer protection duties to the Consumer Financial Protection Agency.

Meanwhile, the Agency for Financial Stability would be responsible for snuffing out systemic risks to the financial system, with the Fed holding just one of its nine seats.

That would leave the Fed with the responsibility of setting monetary policy and little else.

Still, as far as critics are concerned, Bernanke only has himself to blame. After all, it was the Federal Reserve's loose monetary policy and lax oversight that allowed the financial catastrophe brewing in the nation's real estate sector to spiral out of control. And it was Bernanke himself who drastically increased the role of the Federal Reserve, even though the central bank's mandate only required it to ensure stability in the labor market and set monetary policy.

"I feared from the beginning that the Fed's extensive lending operations, instituted without congressional authorization, would embroil it in political disputes, such as over disclosure and who did and did not get assistance," William Poole, former president of the St. Louis Federal Reserve Bank, told Reuters.

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