The Fed and fiscal deficits - stuck in a box

From NYT-

“The arithmetic is, unfortunately, quite clear,” Mr. Bernanke said. “To avoid large and unsustainable budget deficits, the nation will ultimately have to choose among higher taxes, modifications to entitlement programs such as Social Security and Medicare, less spending on everything else from education to defense, or some combination of the above. These choices are difficult, and it always seems easier to put them off — until the day they cannot be put off any more.”

He said a “sharp near-term reduction in our fiscal deficit is probably neither practical nor advisable,” but that a long-term plan for fiscal sustainability could help to lower interest rates and borrowing costs, and even stimulate economic growth.

I heard Niall Ferguson give a talk in Boston the other week with an illuminating story. He argued that the current fiscal situation is like, "War financing without the war". Go back to WWII and you see massive increases in debt to GDP to finance the war effort. The impact was extraordinary and required the Fed to have an Accord with the Treasury to keep rates low. Unfortunately, we know what happens when war financing gets out of control, defaults and inflation.

Chairman Bernanke may know realize that he is in a box. He cannot follow a normal monetary policy of raising rates given the size of the deficits. we usually expect a tightening within 6-9 months after employment starts to turn positive. Can we expect a tightening policy while the structural deficits are still rising? This will be a test of independence.