For Fed, Big Test Will Be When to Turn Off the Money Pump

The Wall Street Journal - During the past eight months, the Federal Reserve has pumped more than $800 billion of cash into the nation's financial system, an action that in normal times could lead to an ugly inflation surge.

Fed Chairman Ben Bernanke is confident that isn't going to happen this time around. To quiet skeptics and reassure markets, he and his lieutenants have been going out of their way the past few days to explain why inflation isn't in the outlook and to lay out the tools they have in hand to fight it.

The focus on inflation isn't just coming from the Fed. In a report this month, Goldman Sachs economists sought to knock down what they described as a wave of "inflation hype" they had been hearing from clients and bond-market traders.

The focus on the issue comes with the Fed's next policy meeting, set for next week. With so many programs already in train, the central bank looks unlikely to take dramatic new actions at the meeting. Assessing signs of improvement in the economy, contingency planning and deliberations on long-term exit strategies are likely to be important parts of the discussions.

Inflation might seem like a distant worry today. Last week, the Labor Department reported that consumer prices in March fell year over year for the first time in 54 years. Rising unemployment and idle factory floors mean businesses have little incentive or capacity to raise wages or the prices they charge customers. There's a risk, in fact, that if the economy weakens much more, the opposite of inflation -- deflation -- could become a serious threat.

That's why the Fed's goal for now is to get inflation higher, not lower. It has effectively been printing money as part of its rescue efforts. When it buys mortgage-backed securities or makes commercial-paper loans, as it has been doing, it electronically credits its counterparty banks with cash in return, which pumps new cash into the financial system.http://online.wsj.com/article/SB124018636521933417.html#mod=todays_us_page_one