Richard Fisher, president of the Dallas Fed, says "from time immemorial any central banker worth his or her salt has been genetically unable to tolerate inflation." That means, among other things, never, ever voting to monetize the debt:
A Perspective on the Economic Outlook, Richard W. Fisher, President of the Federal Reserve Bank of Dallas: ...I want to talk to you today about the economy and about confronting problems ... that loom on the horizon. ... The United States ... data present a less than clear picture. ... [T]he pace of economic growth had begun to slow slightly prior to Katrina and ... the disruptions from Katrina, and later from Rita, would initially slow growth a bit more. The U.S. economy grew at a 3.3 percent annual rate in the second quarter. Now, most forecasters anticipate growth closer to 3 percent in the fourth quarter. Many of them expect the bounce back from rebuilding the Gulf Coast to begin in early 2006, though the impact will be spread over several years. ... Inflation has been on a slight upward tilt the past couple of years. Now, the inflation rate is near the upper end of the Fed's tolerance zone, and it shows little inclination to go in the other direction. We now face higher energy prices and businesses' desire to pass the increased costs on to their customers. Combine the energy spikes with spending increases by governments at every level in the aftermath of the two hurricanes-John Maynard Keynes seems to be the patron saint of both liberals and conservatives these days-and you have new demand pressures added to the old ones. The FOMC has taken note of the fiscal situation, as shown by this pre-Katrina passage from the released minutes of the Aug. 9 meeting: "Few signs were evident that greater fiscal discipline in the budget process would emerge any time soon."
In this environment, the markets, if left to their own devices, would produce higher interest rates to ration money and balance the demand and supply of capital. If the Federal Reserve were to resist the upward pressure on interest rates, it would in effect monetize the burgeoning fiscal deficits. The Federal Reserve has staunchly resisted monetizing deficits for more than a quarter century, and I feel strongly that it can ill afford to monetize them today.
I am glad to see the Fed signaling to fiscal authorities that it will not monetize the debt as it has not, in my opinion (and others) been vocal enough in this area. We have heard from a number of Fed officials this week (here, here, here, and here), and unless there are dramatic changes as new data arrive, interest rates are going up.
[See also: William Polley who discusses Bush's remarks today about not yet having a list of final candidates for Fed Chair and notes his statement that the Chair should be politically independent, as endorsed here.]