Once again I recommend the most recent statement of our Federal Reserve Chair as some of the finest economic analysis you will find anywhere.
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Here are some excerpts:
Consumer price inflation has been elevated so far this year, due in large part to increases in energy prices. Core inflation readings–that is, measures excluding the prices of food and energy–have also been higher in recent months. While monthly inflation data are volatile, core inflation measured over the past three to six months has reached a level that, if sustained, would be at or above the upper end of the range that many economists, including myself, would consider consistent with price stability and the promotion of maximum long-run growth. For example, at annual rates, core inflation as measured by the consumer price index excluding food and energy prices was 3.2 percent over the past three months and 2.8 percent over the past six months. For core inflation based on the price index for personal consumption expenditures, the corresponding three-month and six-month figures are 3.0 percent and 2.3 percent. These are unwelcome developments….
Given recent developments, the medium-term outlook for inflation will receive particular scrutiny. There is a strong consensus among the members of the Federal Open Market Committee that maintaining low and stable inflation is essential for achieving both parts of the dual mandate assigned to the Federal Reserve by the Congress. In particular, the evidence of recent decades, both from the United States and other countries, supports the conclusion that an environment of price stability promotes maximum sustainable growth in employment and output and a more stable real economy. Therefore, the Committee will be vigilant to ensure that the recent pattern of elevated monthly core inflation readings is not sustained.
This statement seemed to catch by surprise some of those who’d decided to label Bernanke as an “inflation dove.” But it shouldn’t have, because the philosophy is exactly the same as Bernanke expressed on February 15:
Inflation prospects are important, not just because price stability is in itself desirable and part of the Federal Reserve’s mandate from the Congress, but also because price stability is essential for strong and stable growth of output and employment. Stable prices promote long-term economic growth by allowing households and firms to make economic decisions and undertake productive activities with fewer concerns about large or unanticipated changes in the price level and their attendant financial consequences. Experience shows that low and stable inflation and inflation expectations are also associated with greater short-term stability in output and employment…
The “inflation dovers” at the time counseled, “yeah, yeah, he’s just saying that, he doesn’t really mean it.” The news to them is that, insofar as incoming data may signal an increase in the public’s inflation expectations, the Fed is actually going to do something about it. But I’ve been telling Econbrowser readers all along that this man says what he means and means what he says. Anybody who claims otherwise just doesn’t know him.
Also getting attention yesterday were these statements from the new Fed Chair:
Consumer spending, which makes up more than two-thirds of total spending, has decelerated noticeably in recent months. One source of this deceleration is higher energy prices, which have had an adverse impact on real household incomes and weighed on consumer attitudes. As had been expected, recent readings also indicate that the housing market is cooling, partly in response to increases in mortgage rates….Gains in payroll employment in recent months have been smaller than their average of the past couple of years, and initial claims for unemployment insurance have edged up.
ABC News quotes this curious reaction from one analyst:
Barry Hyman, equity market strategist with EKN Financial, said the Fed chief is describing an economic situation the market doesn’t want to hear. “Being inflation-vigilant when you’re acknowledging an economic slowdown is not what investors want,” he said. “That scenario borders on stagflation, which is a death sentence for equities should it occur. It’s clear that the market is due for more corrective behavior.”
This is something investors “didn’t want to hear”? But let’s start here– isn’t it true? Would investors prefer to have a Fed Chair who either fails to see, or pretends to fail to see, what should be apparent to anyone with open eyes?
I sure don’t. I’m thankful we have a Fed Chair who understands very clearly that at this particular moment,
monetary policy must be conducted with great care and with close attention to the evolution of the economic outlook as implied by incoming information.
It is indeed a precarious moment. Fortunately, we have one of the smartest people there is at the helm. And he understands exactly what’s at stake here.
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“…something investors “didn’t want to hear”?
“Would investors prefer to have?”
What about ordinary citizens? What are we chopped liver? Is it a precondition of employment in this position that the person will have a predisposition towards “investors” and the rest of us are just a bunch of knuckleheads who will doubtless be better-off when all of the bond-holders and coupon-clippers can drive Escalades?
Forgive me if a simple prole like me shows minimal enthusiasm for “…the finest economic analysis you will find anywhere.” Bernancke tells it like it is for a few members of the ruling elite, the lackeys that spread all this BS and slobs who don’t know aggregate from distributive.
All I have to see is “…core inflation as measured by the consumer price index excluding food and energy prices was…” and I am off into a rant. A large, large number of Americans have three and only three priorities: 1. put the food on the table, 2. put the gas in the tank, and 3. pay the rent to keep the roof over the table. Here we have another genius who addresses those who are figuring “let’s see, can I afford to send Junior to Swarthmore or Harvard?”
My next rant will appear when the sycophants determine that since the cost of owning a residence is flattening and even declining, and pressure is being put on the surrogate rent indicator in the CPI, then it will be time to can surrogate rent from the CPI because it doesn’t accurately reflect ‘real’ cost of purchasing a home.
Wise up!
Thank you for making this point, again. We are at a position in Fed history that is akin to that of the Soviet Union 20 years ago. Back then, an entire generation of Kremlinologists spent their careers deciphering the true meaning of what was being said by Soviet leaders. When Gorbachev came to power and started saying things that were different, the Kremlinologists answered, “no, Gorbachev is just like Brezhnev except that he’s younger and dresses better. He doesn’t mean what he says any more than Brezhnev did. Trust us.” They were wrong but it took time for people to realize this and to start taking Gorbachev at his word.
Bernanke means what he says. The Fed watchers, and the people who listen to them, are going to have to get used to it.
What? A fed chairman telling it like it is? Telling the truth? Balderdash. I want a fed chairman out there with pom-poms made of shredded $100 bills, wearing a skirt fashioned from 30 year bonds, cheering on irrational exuberance while dancing in a shower of t-bill confetti thrown into the air by a contingent of fed economists.
OK. Maybe not.
Good post by the way. I don’t agree with the comment by Charles Roast (above). I think the fed chairman is speaking clearly if the audience is willing to listen. The fed chairman cannot be expected to provide verbal comfort to every american. The fact that the fed is addressing inflation is good for the average american. Inflation is a hidden tax on their standard of living.
Let’s hope the fed can achieve it’s goals without causing too much pain.
Couple other notes: Steven Mufson reviews “Bubble Man” by Peter Hartcher in Washintgon Monthly.[link]. He points out (correctly in my mind) that the fed is often wrongly bashed for allowing bubbles to inflate. Mufson says maybe we should blame ourselves. The fed doesn’t have a knob on the economy to control stupidity.
Finally, there’s been some discussion lately on the idea of gas credits, something I mentioned here many moons ago as a possibly fair means to reduce gasoline demand. In principle, creating a market in credits always seems preferable to taxing, but I may be wrong as I’ve see a few economists indicate that taxing creates less distortion (I’m not sure why). But this proposal, even if principled, seems very impractical. One, it smells like rationing, which of course it is. The public won’t like it. The public forgets that price is also a rationing mechanism. Two, the allocation and trading of credits will be fraught with impracticalities and fraud. And three, it creates an incentive for a black market in gas. So in summary, if politicians want to reduce demand, they will either have to tax or CAFE And as prices–through taxes or the market–increase, they will have to consider what can be done about those who are squeezed out of the transportation market. Angry bear highlights the issue and links to some of the other discussions. [link]
Oh oh, one of the regulatory cores of capitalism is again emerging from its den! To preserve the free market! Cough!
I think Komrade Ben’s first sentence above shows that a monetary response to the current situation is *hopeless*:
“Consumer price inflation has been elevated so far this year, due in large part to increases in energy prices …”
So raise the rates to … get those energy prices down, ey? Not a chance. Hopeless.
Respond to Thomas James:
I agree that one should differentiate between inflation as a pure monetary phenomenon and price increases that result from increased demand on a resource. Though in fact they are very similar. Monetary inflation leads to increased demand. In both cases, supply and demand are out of balance.
In the present case, higher energy prices are working their way through the economy–through the prices of almost everything else. Though I think excess demand due to excessive borrowing (e.g. housing) is also a source.
Whether the inflation is a monetary phenomenon or caused by shortage, I think the solution is to reduce demand. Raising rates is the path in that direction.
I don’t see any problems or inconsistencies. True, the money supply is managed. I’m not sure why that is such a bad thing if done properly.
The Fed is not close
Recently I stated:
The facts suggest that inflation is still in the high range of what the Fed finds acceptable.
Bernanke confers:
Core inflation readings–that is, measures excluding the prices of food and energy–have also been higher in…
TR, I don’t regard the Fed’s moves as inconsistent, just hopeless. Increasing rates will reduce demand—mostly in the US, and to some degree elsewhere, including China, given US prominence in the world economy. But economies of China and other developing nations are IMO too robust, too self-sustaining (and moreso as time goes on) to be too affected by a small US downturn. So here’s one probable course: US demand slows, slowing worldwide demand somewhat, energy prices come down a bit, allowing non-US economies to pick up again, energy being cheaper, causing energy prices to again rise. US is left sitting with highish rates that can’t go down because energy prices did not permanently drop, because they practically cannot: there’s not enough oil. Raising interest rates therefore stands to export GDP. Just a thought.
We’ve had extensive discussions about stagflation on this site before. I was one of the few here who linked lowered economic activity with higher, inflating prices caused, at the core, by higher energy costs.
In fact, higher oil and natural gas costs take some of our economic surplus and transfer ownership to the governments that control the oil and gas resources. For free market energy resources, higher development costs reduce EROEI also yielding less economic surplus from energy use.
With free market producers, they have to spent extra resources on their factors of production ( steel, technicians, oil rigs, etc.) For governments, we see them sometimes investing in political mischief al la Hugo Chavez and Iran.
It will be difficult enough handling stagflation without political inflation – add government printing presses and disaster awaits.
Of course, recent economic preformance has been outstanding by any historical measure so doom-and-gloom is still premature. However, I am reassured that the Fed sees the problems ahead and is forthright in their diagnosis (ie he seems to agree with me.)
Thomas James: I agree with you that, in the end, the fed is not in the business–and can’t–manage the prices of a particular asset or commodity, whether it be stocks, housing, gold, or energy. That is hopeless–as you point out. The economies of the world are probably entering a phase in which energy will consume an increasing part of GDP, unlike the opposite phenomenon that we’ve seen in the past. As that happens, the economy will have to look for growth opportunities that are more energy efficient. And as Joseph points out, what we don’t want to see happen is true monetary inflation as a response to asset/commodity price increases.
The transition to a world of more expensive energy–and a more balanced world economy–both required downward pressure on average living standards in the US, no matter how this pain is distributed. For the time being, this implies slower economic growth–and perhaps a recession in the next couple years. As the DeLong post mentions (that I referenced above), a reallocation will be necessary, from building speculative housing to either (a) exporting more or (b) creating more of what we import or (c) doing without.
I don’t see any way around a slower economy. Though the fed may be attacking something other than true monetary inflation as it discusses energy induced inflation, I think in the end it’s only option is to constrain the money supply in order to reduce demand.
Hopeless? If you believe in peak oil, as I do, then yes, the fed cannot create energy. The fed can only attempt to provide some measure of stability in an aggregate concept of money and pricing. It’s a political and market question of what we do with that. But I’d prefer to see the fed put a damper on what I still find to be a highly speculative environment (housing prices, historically high P/Es, etc).
Charles Roast, I hear Bernanke say, “an environment of price stability promotes maximum sustainable growth in employment and output and a more stable real economy,” and you hear him say, “can I afford to send Junior to Swarthmore or Harvard?” I’m not sure how best to try to bridge this communication gap, other than to offer my belief that it’s always more productive to respond to what people actually say rather than to what you suppose they are secretly thinking.
I do not see how one could defend the claim that sustainable growth in employment and output and a more stable real economy are contrary to the interests of the “large, large number of Americans” on whose behalf you claim to speak. And if it is your position that Bernanke in fact does not seek to promote sustainable growth in employment and output and a more stable real economy, then you are making an even greater miscalculation than have those I dubbed the “inflation dovers”.
TR, I agree with your observations, and I agree that even absent rising energy costs the housing market required defrothing.
On the other hand, I question whether raising interest rates will promote maximum sustainable growth and “a more stable real economy.” Monetary inflation skews supply/demand by (artificially, “unreally”) increasing demand. And as you say, an economic environment of increasing energy costs looks in some appearances like inflation: skewed supply/demand, rising prices, etc. Of course the critical difference between true inflation and supply-constrained energy price increases is the former is a demand problem, the latter a supply problem. In light of that difference, and apart from the housing problem, why not let prices rise—a “real” price rise—to allow the economy to operate on a more real basis? Why, in other words, reduce economic output to in turn reduce the probability economic actors will produce real solutions to our problems?
Many of the “inflation dovers” point to Bernanke’s famous “helicopter” speech as evidence of his dovishness. As I argued here, they have it 180 degrees wrong. Confidence about the Fed’s ability to handle deflation is a good reason to err on the side of too little inflation rather than too much.
I don’t care how smart Bernanke is, the question is, how is he going to make a decade of 8% money supply inflation go away without a crippling deflation or terminal hyperinflation?
If he’s found a third way, he would indeed be deserving of praise for uncommon intelligence.
Two points. First, in his Stagflation post on May 17, JDH measured the difference between rates on treasury securities and inflation-protected securities:
https://econbrowser.com/archives/2006/05/stagflation_1.html
I just checked the data and although at the time the measures had widened by .4% since the start of the year, they have since narrowed by .1%. So the Fed’s inflation-fighting intentions are getting through to the market, it seems.
Second, it is commonly stated that commodity price increases, such as for oil, will cause inflation. This is not true. What happens is this.
There are two effects which a business must face in responding to an energy price rise. It may see an increase in its costs as oil and gas gets more expensive. But, on the other hand, it may see a reduction in demand by its customers. The reason is that the customers have higher expenses in other areas and have less to spend. Depending on the relative strength of these two effects, a business may find itself pressured to either raise or lower prices.
We can classify businesses in terms of how sensitive they are to energy prices – how much of their costs correspond to energy. Some, like oil companies, are extremely sensitive. Others, like accountants, are much less so. Many businesses will be in the middle, or median, in terms of energy sensitivity.
What should happen, with a price increase for energy commodities, is that businesses with greater than average sensitivity end up raising prices, and businesses with less than average sensitivity end up lowering prices. Overall price levels remain about the same, and there is no inflation. Patterns of expenditure change as people economize on goods that are highly sensitive to energy prices and shift their expenditures more to goods that have relatively less sensitivity.
In practice, these kinds of changes and shifts are costly to the economy, which is optimized and tuned for previous expenditure patterns. Also, some of the price-lowering above includes prices of labor – in other words, some people have to take pay cuts, which they are reluctant to accept. In order to postpone and minimize these costs, the Fed and government will often intervene and add liquidity, so that people can continue to spend and no one has to accept lower prices and wages.
It is this liquidity which ultimately causes overall price inflation. This is why commodity price increases are generally viewed as inflationary, because the government is seldom willing to stand by and let the market go through painful adjustments. But in principle, commodity and energy price increases in themselves are not inflationary.
JDH
I hear what Bernanke is saying, and his language is that of an institutional economist. He is certainly a good modeler and I’m sure he is great at fashioning numbers and theories into perfectly acceptable objective conclusions about the state of the economy…completely value free. A simple mirror, accurately sifting the market tumult and reflecting a reality that soothes the hyper-sensitivities of the business and political elites (is there a difference?).
In my days as an undergraduate we would laugh and call these guys “obscurantists”. Then the Great Putsch occurred at Harvard in the early 70’s, and even those of us at the lesser schools got the message…”the practice of academic economics is about business, not about political-economic dynamics.” Get with the program or find yourself teaching at Fitchburg State.
Yeah, I understand the language. More importantly, I understand the historical and current subtext.
You guys are missing the point on what Mr. Roast is saying.
The money supply expansion is baked in the cake. The Fed did it. It is, in fact, its raison d’etre. But this always, always, always ends in broad asset price increases, which hits the worst-off hardest.
There’s nothing Bernanke can do to erase this past… and what the government does for the most vulnerable in the near future will tell us whether they care more about, metaphorically, which Ivy their kids go to, or the well-being of the people in society their monetary policies have harmed the most.
Further rate rises will be a coup for banks (the wealthy), and those long on credit will ever more see their houses hauled to the repo yard. Should lead to what the business press calls astounding or ebullient or overflowing profits, code language for further middle-class suckout or something.
I pretty much concur with many of the observations made by Thomas James, Hal, and others. Monetary inflation and demand/supply imbalances are separate issues. In the Washington Monthly review I mentioned above, Mufson grants that Greenspan missed an opportunity to defroth the stock market when the opportunity existed (in between crises, e.g. Asia and LTCM). In the same way, I think an opportunity exists right now to at least to a degree set in path some form of defrothing of the housing market and to raise the cost of money.
This will not address energy prices. As many have noted, higher energy prices simply mean a different allocation of goods and services in the economy (towards energy producers). Which puts downward pressure on other non-essential goods and services. The fed cannot control this.
So why does the fed talk about inflation when higher energy costs propagate through the economy? I think others have brought up a good point: we’ve existed in a low-cost-of-money environment for far too many years, borrowing against future goods and services.
Right now, we have an opportunity to rectify this a bit by continuing with a high-cost-of-funds environment.
Remember the old saying you can’t win for losing. When money is cheap, when interest rates are low, the fed is lectured for cutting into the interest income of the elderly. When the interest rates are going up, the fed is accused of stealing food from the mouth of babes.
These are political issues. I’m in the camp of those who find economics, particularly its neo-liberal forms, highly ideological in many ways, making policy prescriptions when they are not warranted, theoretically and experimentally justifiable, nor compassionate or making sense in terms of good values.
But I just see no reason to think like that with respect to monetary theory. True, the fed has bailed out some high level players. When a house of cars is about to fall, when money flows out of hedge funds or entire economies, the fed rushes in to save the day. The big players are not allowed to fall. But there is a good reason to do this. That is the system we have, with some big players. And when they get into trouble, everyone ends up getting hurt. The fed can’t help everyone, but if it has to step in to help a big player, it will.
That is a form of social welfare in a sense. But that is not a problem with monetary theory or that narrow branch of economics. That is a problem with the wider neo-liberal tradition which argues that free markets are efficient and that there is little or no need for inteference (e.g. social welfare or other such matters) to address inefficiencies. But these are political as much as economic issues. It’s just that there are many economics–or more likely pundits who speak in neo-liberal economic terms–who are trying to present themselves as non-ideological when making policy prescriptions. They want to appear as scientists.
With respect to this discussion with the fed, one has to always keep stability in mind. It would be nice, all things considered,if we lived in a society in which goods are shared more broadly. But any broad attempts to reorganize society in a way that meets those ends is just as likely to look something like that streets of Iraq than it would some Swedish welfare state. In other words, one should–unless absolutely necessary–nudge a system towards a particular goal, trying to edge a way around instabilities.
Right now, there are some economic instabilities that exist in the world. There is a lot of nudging that has to take place to (a) deal with high energy prices because of supply problems (b) deal with an overhang of cheap money that has inflated the price of assets such as housing–and stock if you ask me, considering historical P/Es and (c) the American attempt to serve as the consumer of the world by outsouring our productive capabilities while borrowing to maintain consumption.
There’s a lot of nudging that needs to be done. The fed seems to be headed in a reasonable direction.
Hal, your point about commodities does not hold up in the context of a competitive equilibrium. Sure, an individual business, if it has some monopoly power, may react to commodity price increases by cutting its own prices as demand for its product goes down. But in a competitive market, businesses operate on thin margins and do not have the luxury of cutting prices. When their input prices go up, they either raise prices or go out of business.
I think Ben is making perfect sense. What I think this discussion is lacking is acknowledgement that global liquidity and monetary excess has caused this to begin with. Global economic growth caused by the “asset pump” of BOJ, Fed and EU policies is what got us here. After 2001 they needed to mitigate risk premiums to get people to invest and engage in economic activity. Problem is, instead of real economic growth with job creation and real wage gains, we got speculative investment and consumption based on asett gains and access to credit.
How does the fed and BOJ and EU now remove that goose (because it is causing commodity inflation) and return us back to life without the monetary steriods and not bring down the damn circus? We depend too much on consumer spending–consumers depend too much on access to credit or spending of perceived asett derived wealth because real wage growth isn’t there for most Americans–
-IMO the Fed is trapped by the sad new realities that global labor arbitrage has produced. Equity bubble of the 1990s and housing bubble of now have only masked a reality that has been emerging for many years. the latest bubble is in commodities prices as investors look anywhere to find yield.
More importantly, how can we stimulate real Capex by businesses here in the US in an environment where it may not make the most sense(as current policies have it) given the new global realities?
Don’t think that this is the dark nightmare behind the fleeting inconvenience
That’s a great phrase “global labor arbitrage.” With the opening of China, we saw a one third step increase in global labor supply with low overhead. That’s gotta cause economic readjustments. How about Chinese banks with $1 trillion of shakey loans?
As to real wage growth in the US, productivity gains are usually considered the underlying cause and a positive one. Someone pointed out that in the US, 2/3 of those officially in poverty have air conditioning and a microwave oven.
I think that most commenters still don’t grasp (or agree with) the fundamental issue of energy as the driver of an economy. The more energy and the easier and cheaper (absolutely and relative to other factors), the faster a free economy can grow. Constrain energy or make its production require more resources then the whole system becomes less productive and yields less wealth.
Joseph, your observation re energy as the fundamental baseline for production (directed, I might add, by information, so an energy-information economy) has to be correct. I can produce about 150 watts of energy on my rower for about 4 minutes, then I must break for a rest = 240 wattseconds = the energy in 1/25,500,000,000 of a barrel of oil (assuming oil has 5.8×10^9 BTU). I mean, who’s doing the work in our economy, me or oil (electricity etc)?
Fox news is making real sure that as we approach the midterms Gentle Ben is painted as the cause of any brewing economic troubles. Watch Gentle Ben catch javelins, folks !!
With high GDP growth in the PBRIC countries causing the huge demand in commodities and inflated prices for them, One has to wonder how The Fed can reduce this global demand for new infrastructure based on the change from a communistic way to a more free market world..
While I understand many folks who frequent JDH’s blog believe government is no good for anything economics-related, the current situation demonstrates a perfect role for government action.
There’s very little argument that energy prices are being driven higher, that this is filtering into core inflation, that this is very difficult on the common man as well as the poor American soldier who must often pay with his life to preserve the state of this oil-absorbed nation.
We also concurrently have a situation where wage and total compensation growth is low, and global labor arbitrage is putting heavy pressure on US workers.
The current aggregate situation begs that government action to steer investment toward generating energy from better sources. We need to employ people to build wind farms, solar fields. Putting politics aside, we could employ lots of folks to build nuclear energy sources. There’s the alternative fuel types that are burgeoning. Better transportation systems could be built and employ millions.
This new energy industry could help replace lost manufacturing sector jobs and is, or certainly will be, a generator of exportable goods to help with the trade deficit.
Private interests won’t do this because it’s not sufficiently profitable. But government policy can make it sufficiently profitable. A $5000 energy infrastructure tax on each huge SUV sold, for example, the proceeds from which would go to build said infrastructure.
James, I know how you hate government. But this is a place where only government action can get the best result. We have big problems, so big that only government strategy and incentivising has a chance at resolving things.
Too bad most of those in our government aren’t apparently terribly interested in the actual welfare of the nation. Go gay marriage amendment!
So believe me, I know this is all theoretical.
Thanks, Alan. I feel so much better now about paying that $1,000 gas guzzler tax on my 2005 Pontiac GTO – and the state sales tax of almost 8% on that federal tax. Taxes on taxes!
While I make my car and tax payments from my salary building nuclear power plants internationally, I can feel better that at least some of my labor is going to US government subsidies for domestic wind mills and solar panels. That is, if I felt those options weren’t a huge waste of money.
That said, I have to agree with you in concept that government has a role in guiding and spurring deep infrastructure development. however, the devil is in the details.
The coming boom in energy projects will, as you note, pull more people, capital, and resources from other economic activities. Steel for pipelines will compete with steel for bridges. Power plant bonds will compete with new school bonds. We will divert students from law schools into engineering schools by higher salaries (OK, a net social positive!)
“Bernanke tells it like it is”
The folks at Econbrowser take a look at Fed Chairman Ben Bernanke’s latest statement.
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