Obama, Bernanke need miracles

Specifically, it will be a time to test the validity of certain economic principles, such as the notion that government needs to spend money to save money. Already the Obama administration has been embarrassed, by shoddy data and sheer hubris, into rejigging its measure of “jobs created or saved” as a result of the US$787 billion fiscal stimulus.

Now it's even mushier. All jobs funded by the American Reinvestment and Recovery Act will be counted, even if they predated the cash infusion.

Here are some other areas that bear watching.

Federal Reserve

For all its talk about an exit strategy, the Federal Reserve is about to learn that getting out is harder than getting in.

Politically, raising interest rates is not a way for the central bank to win friends and influence people on Capitol Hill. Doing it at a time when the unemployment rate is unacceptably high will make Fed Chairman, Ben Bernanke, the most sought-after guest at congressional committee hearings, which are all sure to have the atmosphere of a lynching. Just ask Paul Volcker.

As a practical matter, the Fed has various options in its toolkit to prevent its bloated balance sheet from translating into excess money and credit growth and ultimately inflation.

It can sell securities outright. It can drain reserves on a temporary basis — the equivalent of borrowing money from the banking system — through reverse repurchase agreements or a recently proposed program of term-deposit sales. And it can raise the interest rate it pays on reserves, currently 25 basis points, to induce banks to hold their excess reserves at the Fed instead of lending them out.

Once private markets are fully functional and the economy is on a stronger footing, what risk-free rate will it take to discourage banks from making those loans? Will it be the same for every bank? How does the Fed know, except through trial and error? And what if too many errors upend the trial?

Federal Budget

For President Barack Obama, 2010 will be the year of fiscal responsibility — once health care and another jobs bill are enacted. Now is the time to get serious about the deficit, which hit a record US$1.4 trillion in fiscal 2009, or 9.9 percent of gross domestic product, the biggest share since 1945.

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