Bending it like Bernanke shows error of Fed ways

"So you want to be in charge of monetary policy?" asks the education section of the Federal Reserve's Web site. "Think you have what it takes to steer our country's central bank? See how it works by taking charge of a simulated economy."

Yes, please! What a hoot! "Your goal is to get reappointed," says the site. Wow, so much for the altruism of public service. I always suspected it was all about hanging on to the job rather than safeguarding the economic prosperity of 300 million Americans, and here's the Fed confirming my skepticism.

Rather than simply follow the random walk of my own egocentric inclinations, however, I wondered how the Fed's model of the US economy would react to the decisions its chairman Ben Bernanke has taken recently. So I don my flight jacket, climb into the helicopter, and prepare to bend it like Bernanke.

The game begins with the Fed rate at 4.5 per cent, which is where policy stood in December before the central bank took fright and slashed borrowing costs. "Fed Chair Appointed," say the imaginary newspaper headlines that flash up on the site. "Inflation Rising; Fed Expected to Raise Rates." Unemployment is 4.75 per cent, while inflation is 2.14 per cent.

My first move is a cut to 4.25 per cent, as the Fed did in December. "Rising Inflation Fears," says the newspaper. "Experts Say Interest Rates Must Go Higher." Ha! What do they know? I'm in charge here! Unemployment declines to 4.69 per cent, inflation accelerates to 2.26 per cent.

Unlike the real Fed, the Web site Fed won't let me change course between meetings, so I have to wait to replicate the Jan. 22 emergency measure of driving the target rate down to 3.5 per cent. "New Policy Set to Encourage Expansion," applauds the newspaper. My second term in office is looking like a shoe-in with the jobless rate dropping to 4.57 per cent, though consumer prices are now rising at 2.4 per cent a year.

My third move is also straight from Bernanke's playbook, mirroring the January 30 half-point cut to push the Fed rate down to 3 per cent. It turns out to be a risky strategy. "Inflationary Pressure," the headlines warn. "Employment Strong but Price Index Rising." The jobless rate dips to 4.29 per cent, inflation speeds to 2.61 per cent.

At this point, with both the real and imaginary key interest rates at the same level, I'm still doing a bit better than Bernanke. He is currently wrestling with a 4.1 per cent inflation rate and a 4.9 per cent jobless figure. From here, though, I'm flying blind without Bernanke as my co-pilot, relying instead on what traders and economists expect the Fed to do to guide my future policy decisions.

Prices in the futures market suggest there's a 98 per cent chance of a further half-point reduction at the Fed's March 18 meeting, so that's what I do on my next turn at the game.

"Extra!" hollers the newspaper headline. "Dollar Down Overseas, Cost of Imports to US Rising Sharply." Unemployment swings down to 3.26 per cent, while consumer prices bust higher at 3.51 per cent.

Still, the futures market tells me my work here isn't done yet so I cut again, acceding to predictions for a quarter-point reduction on April 30. "Extra!" screams the newspaper. "Dollar Continues to Fall. Fed Expected to Raise Rates as Prices Rise.''

With the Fed funds rate now 2.25 per cent, I've goosed the economy so hard that joblessness is down to 2.28 per cent. That's the lowest since at least 1948, the earliest date for which Bloomberg has data from the Bureau of Labor Statistics. Consumer prices, though, are now rising at an annual pace of 4.72 per cent. I hate to think what the Treasury market would be doing. The futures market suggests the Fed might pause at about 2 per cent. Not so David Rosenberg, the chief economist for North America at Merrill Lynch & Co., who said last month that the Fed will need to lower borrowing costs to 1 per cent as a recession grips the economy.

Armed with that prediction, I attack the Fed's Web site with five more clicks on the minus button.

Unemployment instantly drops to 1.5 per cent "� and stays there as the Fed's model gets stuck at what it clearly views as the natural jobless rate. The headline writers, meantime, are clearly too busy buying canned food and bottled water to turn up for work; consecutive rate cuts are greeted with the same newspaper headline, "Fed Cuts Interest Rates, Unexpected Move May Worsen Inflation."

May? There's no "may" about it. Consumer prices rocket higher in full percentage-point leaps, passing 6.21 per cent, 7.38 per cent and 8.62 per cent. Inflation passes 10 per cent after my penultimate policy move.

By the time I have driven the Fed funds rate down to the 1 per cent level suggested by Merrill's Rosenberg, inflation is at an eye-popping, 1970s-oil-crisis level of 11.58 per cent "� and I'm pretty sure I'm no longer in charge of monetary policy, having been dragged off to the funny farm in a tailored white jacket that only buttons at the back.