"Heroing is one of the shortest-lived professions" - Will Rogers (1879 - 1935)
Greenspan managed to leave a complicated legacy to the new Fed chair Ben Bernanke. While the enormous boost in the money supply, presided over by Alan Greenspan has so far seemed benign, unwinding such a vast excess will be a great challenge to Bernanke. Withdrawing all the excess liquidity would produce a recession, and everything that Bernanke stands for suggests that this path is not his preferred outcome. Nevertheless, Bernanke will need to tighten enough to regain sufficient control of inflation to keep the economy, at least to some extent, stable.
No doubt, Bernanke is all too aware of the risk of tightening policy too quickly. The main engine of the economy in recent years has clearly been the housing market, and with inventories of unsold homes already at record high levels, further aggressive tightening could well be disastrous. However, this may well be the risk he has to take to regain control of the economy.
This is where excessive use of money supply inevitably leads - to highly unstable economic conditions. It also leads in the end to a less efficient economy as planning and investment becomes so much more difficult with a volatile economic background. It also means that in the long term the risk of runaway inflation increases. While Bernanke is currently trying to restrain demand, he is clearly and candidly on record as a strong believer in using excessive money supply to counter any risk of a major economic downturn. This means that over the economic cycle, the excessive use of money supply as a policy tool, that was introduced by Greenspan will continue with Bernanke at the helm.
This impression is strongly reinforced by the background of substantial budget deficits as far as the eye can see. Unless financial discipline can be restored, which involves a degree of unavoidable restraint and hardship, then there will be a great temptation to once again use excessive money supply to inflate away much of the debt. One way or another, we have clearly entered an era in which excessive money supply manipulation will remain very much at the forefront of policy management at the Federal Reserve.