U.S. Fed did the right thing by stoking economy. But now what?

Deciding if and when to sell trillions worth of bonds is a crucial choice

Now comes the hard part. The U.S. economy generated 288,000 new jobs in June, its best monthly performance in two years and fourth-best since recovery began in 2010. The unemployment rate fell to 6.1 per cent, not great in historical terms but a lot better than the 10 per cent it hit in 2009, not to mention our own current seven per cent.

Since the Crash of 2008, the U. S. Federal Reserve has been pumping, pouring, gushing liquidity — money — into the economy. When interest rates for the short-term government bonds it typically trades in fell to zero, it started doing things atypically, buying longer-term government bonds in order to force down their interest rates and thus make it easier for borrowers to finance the real investments — houses, factories, machines, you name it — that help employ people.

When a buyer as big as the Fed moves into the bond market, that automatically brings interest rates down: More buyers bidding for loans means the sellers of new loans — borrowers — don’t have to offer as much interest. And it worked. Interest rates have been rock-bottom for five years now and have slowly stoked the economy, which finally seems to be hitting cruising speed.

The flip side of all that Fed bond-buying is the creation of mountains of money. The Fed hasn’t actually printed the new money. Mainly it has bought bonds from financial institutions by depositing “money” into their accounts at the Fed: All federally regulated banks and many other institutions have such accounts. The Fed can increase the balance in them with a few keystrokes.

So the Fed’s big expansion of the money supply hasn’t killed as many trees as the numbers might suggest. But the Fed has been very, very active. When the Crash hit, it had about $900 billion in assets. Now it has $4.4 trillion, which is an awful lot of money created. A website devoted to big numbers says that a stack of $4.4 trillion in $1 U. S. bills would stand, albeit very tippily, almost 300,000 miles high, farther than the moon. If you laid all those bills side by side you could almost completely cover the states of Massachusetts and Maryland, though people would probably start picking them up before you finished.

Trees may not have been endangered by the Fed’s policy. How about price stability? Doesn’t money creation on such a scale risk inflation?

It does, assuming all the money ends up being spent in an economy operating close to flat out. So far we’ve been safe on both counts. Since 2008 the U. S. economy has had excess capacity — both in under-used plants and equipment and unemployed people. And much of the new money hasn’t entered the economy. Financial institutions may have lent recklessly before 2008 but have been very cautious since. Most new money has stayed on deposit with the Fed, where it earns modest interest.

But if everybody now gets the idea the recovery is finally fully under way, does that gigantic pile of stored-up liquidity now come splashing into an economy oper- ating much closer to its capacity output and start pushing prices up?

That’s the big danger, maybe still not quite yet but soon.

In central banking as in comedy, timing is critical. One famous definition of a central bank’s job is taking away the punch bowl just as the party’s getting started.

When the Fed starts selling all the bonds it has bought, thus now competing with new borrowers in the market for loans, that will force up the interest rates those borrowers have to pay.

If they’re gung-ho on the economy, they’ll invest nevertheless. If they’re still a little squeamish, higher rates may choke off growth.

In 2008, with all indicators falling off a cliff, it was easy to know when to act. Now it’s much more of a judgment call — one that for all our sakes, central bankers had better get right.