i think we must face it ..........., page-29

SaturnV,

Yes, you're right - Bernanke thinks that he can deal with any future inflation worries, by "draining" the liquidity he's been injecting over the past year or so. I don't believe that for one second, but the important thing to remember is that he does and, for the moment, he is the one who is important in that scenario.

As regards inflation targeting, he's talking about something slightly different from the "norm" when he says that. In the past, inflation targeting has been shorthand for keeping inflation low. However, Bernanke's use of the term recently has been to actually "create" inflation.

Remember that no monetary economist wants to be trapped at the zero-bound cash rate. The reason that is happening at present, is because the bond market is pricing in deflation and therefore are more concerned about preservation of capital, and bugger the (lack) of interest rate! Bernanke wants people to be convinced that he can create inflation, if he wants. In fact, his entire career has been built around how to escape deflation.

As regards draining this excess liquidity later, before inflationary expectations really take hold, I think he has a snowball's chance in hell, for two main reasons: the expansion of the Fed's balance sheet is just so massive that it could not be drained in any short-term/orderly fashion, without totally cratering the economy; and they exchanged too many treasuries for crap assets at over-inflated prices, that you may as well immediately write-off at least 30% of the balance sheet expansion as gone forever (although the bond market is presently optimistic about those values - why do you think the Fed refuses to tell Bloomberg News where that $2 trillion went?).

So, I think that Bernanke will suceed in creating inflation, because everybody, including the bond market, are underestimating his will to continue printing until it happens. When the bond market finally realizes this (in one of those "Oh, no!" moments), the "return-free risk", as Jim Grant puts it, of owning treasuries at present prices will dawn on everyone at once and US treasuries will drop like a proverbial rock.

[Of course, there is always the possibility that Obama could ask Bernanke to leave early. That would be a Black Swan event for the bond market.]