from Ken Landon, J.P.Morgan Strategy, NY (Oct 15, 2010)
* BERNANKE – There is plenty to digest and many points that can be discussed about the Chairman’s speech, which carries the title “Monetary Policy Objectives and Tools in a Low-Inflation Environment.” Instead of commenting on everything, I will focus just on things that interest me and that I have not written about before.
1) First, the opening passage is an ode to higher inflation. According to the Chairman, central banks won the war against inflation in the 1980s through the 2000s (i.e., they won the war against a phenomenon that they themselves created), but now policymakers must focus on preventing the opposite bogeyman (i.e., too low inflation or even deflation).
2) Bernanke: “a single-minded focus by the central bank on price stability, with no attention at all to other factors, could lead to more frequent and deeper slumps in economic activity and employment with little benefit in terms of long-run inflation performance.”
My comment: When I read that sentence, the word “could” jumped out at me. In other words, the Chairman could not quite bring himself to using a definitive “will” because, in my opinion, the statement is not proveable. Yes, such a single-minded policy “could” lead to more frequent “slumps,” but it “could” also lead to more stable growth. Bernanke obviously chose to focus on one tail risk and ignore the other when making that statement.
As an aside, there was an era when the management of money was not in the hands of politicians. Those were the days when bank managers had a “single-minded” focus on the stability of the value of the currency issued. In those days of competition between issuers of currencies, it was fatal not to have such a “single-minded” focus. There were no legal tender laws forcing anyone to accept the currency of one bank or another. During the 100 years prior to the establishment of the Fed, the US experienced both high average growth and ZERO average inflation. Yes, there were times when prices moved higher (inflation) and times when prices moved lower (deflation), but the average was zero. It was during that period that the country experienced the Industrial Revolution and high growth. There is plenty of historic precedent of periods in which inflation was non-existent and growth was high.
3) Bernanke: “Recognizing the interactions between the two parts of our mandate, the FOMC has found it useful to frame our dual mandate in terms of the longer-run sustainable rate of unemployment and the mandate-consistent inflation rate. The longer-run sustainable rate of unemployment is the rate of unemployment that the economy can maintain without generating upward or downward pressure on inflation.”
My comment: the above is illustrative of the demand-side view of the Fed. They really do believe that inflation is *caused* by things such as higher wages or rising prices of healthcare, etc. From their own words, it is not apparent that they understand that inflation is a decline in the purchasing power of money and changes in overall wages and other prices are *effects* and not *causes*.
4) Bernanke: “Empirical evidence suggests that our previous program of securities purchases was successful in bringing down longer-term interest rates and thereby supporting the economic recovery.”
My comment: “Suggests”? This indicates uncertainty about the validity of the policy. The effect of the policy on bringing down longer-term interest rates is not something that I would question here. I think Fed action did in fact lower those rates. However, what is questionable is the conclusion that such action supported the economic recovery. Lower long-term rates and flatter yield curves are usually associated with slower future growth and not higher. Changes in short-term interest rates have a much higher explanatory power for future growth than do changes in long-term rates. The Fed can indeed pull down long-term rates with aggressive debt monetization, but it does not have the power to positively affect the economy by doing so. The Japanese tried this exact same policy over the past decade or so and they failed miserably in boosting growth.
I’m done with commenting on the speech. I intentionally left out a lot of material because much of it was a rehash of previous statements of either Bernanke or the FOMC. The message that Bernanke conveyed today was the same as what the market has been pricing, which is an imminent increase in debt monetization. That is, Bernanke did not break new ground. He merely confirmed the market’s expectations.
full speech: http://tinyurl.com/28fkwtv
* BERNANKE – There is plenty to digest and many points that can be discussed about the Chairman’s speech, which carries the title “Monetary Policy Objectives and Tools in a Low-Inflation Environment.” Instead of commenting on everything, I will focus just on things that interest me and that I have not written about before.
1) First, the opening passage is an ode to higher inflation. According to the Chairman, central banks won the war against inflation in the 1980s through the 2000s (i.e., they won the war against a phenomenon that they themselves created), but now policymakers must focus on preventing the opposite bogeyman (i.e., too low inflation or even deflation).
2) Bernanke: “a single-minded focus by the central bank on price stability, with no attention at all to other factors, could lead to more frequent and deeper slumps in economic activity and employment with little benefit in terms of long-run inflation performance.”
My comment: When I read that sentence, the word “could” jumped out at me. In other words, the Chairman could not quite bring himself to using a definitive “will” because, in my opinion, the statement is not proveable. Yes, such a single-minded policy “could” lead to more frequent “slumps,” but it “could” also lead to more stable growth. Bernanke obviously chose to focus on one tail risk and ignore the other when making that statement.
As an aside, there was an era when the management of money was not in the hands of politicians. Those were the days when bank managers had a “single-minded” focus on the stability of the value of the currency issued. In those days of competition between issuers of currencies, it was fatal not to have such a “single-minded” focus. There were no legal tender laws forcing anyone to accept the currency of one bank or another. During the 100 years prior to the establishment of the Fed, the US experienced both high average growth and ZERO average inflation. Yes, there were times when prices moved higher (inflation) and times when prices moved lower (deflation), but the average was zero. It was during that period that the country experienced the Industrial Revolution and high growth. There is plenty of historic precedent of periods in which inflation was non-existent and growth was high.
3) Bernanke: “Recognizing the interactions between the two parts of our mandate, the FOMC has found it useful to frame our dual mandate in terms of the longer-run sustainable rate of unemployment and the mandate-consistent inflation rate. The longer-run sustainable rate of unemployment is the rate of unemployment that the economy can maintain without generating upward or downward pressure on inflation.”
My comment: the above is illustrative of the demand-side view of the Fed. They really do believe that inflation is *caused* by things such as higher wages or rising prices of healthcare, etc. From their own words, it is not apparent that they understand that inflation is a decline in the purchasing power of money and changes in overall wages and other prices are *effects* and not *causes*.
4) Bernanke: “Empirical evidence suggests that our previous program of securities purchases was successful in bringing down longer-term interest rates and thereby supporting the economic recovery.”
My comment: “Suggests”? This indicates uncertainty about the validity of the policy. The effect of the policy on bringing down longer-term interest rates is not something that I would question here. I think Fed action did in fact lower those rates. However, what is questionable is the conclusion that such action supported the economic recovery. Lower long-term rates and flatter yield curves are usually associated with slower future growth and not higher. Changes in short-term interest rates have a much higher explanatory power for future growth than do changes in long-term rates. The Fed can indeed pull down long-term rates with aggressive debt monetization, but it does not have the power to positively affect the economy by doing so. The Japanese tried this exact same policy over the past decade or so and they failed miserably in boosting growth.
I’m done with commenting on the speech. I intentionally left out a lot of material because much of it was a rehash of previous statements of either Bernanke or the FOMC. The message that Bernanke conveyed today was the same as what the market has been pricing, which is an imminent increase in debt monetization. That is, Bernanke did not break new ground. He merely confirmed the market’s expectations.
full speech: http://tinyurl.com/28fkwtv
