May 02, 2006
Reading Bernanke's lips
I still say that many pundits are using the wrong paradigm for interpreting the public pronouncements of the new Federal Reserve Chair.
The latest miscommunications originated with Bernanke's testimony before Congress last week. Here are the key things that Bernanke said:
Based on the information in hand, it seems reasonable to expect that economic growth will moderate toward a more sustainable pace as the year progresses. In particular, one sector that is showing signs of softening is the residential housing market. Both new and existing home sales have dropped back, on net, from their peaks of last summer and early fall. And, while unusually mild weather gave a lift to new housing starts earlier this year, the reading for March points to a slowing in the pace of homebuilding as well. House prices, which have increased rapidly during the past several years, appear to be in the process of decelerating, which will imply slower additions to household wealth and, thereby, less impetus to consumer spending. At this point, the available data on the housing market, together with ongoing support for housing demand from factors such as strong job creation and still-low mortgage rates, suggest that this sector will most likely experience a gradual cooling rather than a sharp slowdown. However, significant uncertainty attends the outlook for housing, and the risk exists that a slowdown more pronounced than we currently expect could prove a drag on growth this year and next. The Federal Reserve will continue to monitor housing markets closely.
More broadly, the prospects for maintaining economic growth at a solid pace in the period ahead appear good, although growth rates may well vary quarter to quarter as the economy downshifts from the first-quarter spurt. Productivity growth, job creation, and capital spending are all strong, and continued expansion in the economies of our trading partners seems likely to boost our export sector. That said, energy prices remain a concern: The nominal price of crude oil has risen recently to new highs, and gasoline prices are also up sharply. Rising energy prices pose risks to both economic activity and inflation. If energy prices stabilize this year, even at a high level, their adverse effects on both growth and inflation should diminish somewhat over time. However, as the world has little spare oil production capacity, periodic spikes in oil prices remain a possibility.
The outlook for inflation is reasonably favorable but carries some risks. Increases in energy prices have pushed up overall consumer price inflation over the past year or so. However, inflation in core price indexes, which in the past has been a better indicator of longer-term inflation trends, has remained roughly stable over the past year. Among the factors restraining core inflation are ongoing gains in productivity, which have helped to hold unit labor costs in check, and strong domestic and international competition in product markets, which have restrained the ability of firms to pass cost increases on to consumers. The stability of core inflation is also enhanced by the fact that long-term inflation expectations--as measured by surveys and by comparing yields on nominal and indexed Treasury securities--appear to remain well-anchored. Of course, inflation expectations will remain low only so long as the Federal Reserve demonstrates its commitment to price stability. As to inflation risks, I have already noted that continuing growth in aggregate demand in excess of increases in the economy's underlying productive capacity would likely lead to increased inflationary pressures. In addition, although pass-through from energy and commodity price increases to core inflation has thus far been limited, the risk exists that strengthening demand for final products could allow firms to pass on a greater portion of their cost increases in the future....
The FOMC will continue to monitor the incoming data closely to assess the prospects for both growth and inflation. In particular, even if in the Committee's judgment the risks to its objectives are not entirely balanced, at some point in the future the Committee may decide to take no action at one or more meetings in the interest of allowing more time to receive information relevant to the outlook. Of course, a decision to take no action at a particular meeting does not preclude actions at subsequent meetings, and the Committee will not hesitate to act when it determines that doing so is needed to foster the achievement of the Federal Reserve's mandated objectives.
Out of these words came some great theorizing that such statements established Bernanke as an inflation dove, followed by complaints (e.g., , , , ) at the informal manner in which Bernanke tried to correct this misapprehension through casual communications with TV news personality Maria Bartiromo.
But suppose you were asked to read the text quoted above, and were told that this was not the great pronouncement of the Mighty Fed Chair which had to be cleverly reinterpreted in order to divine what he really means, but instead was just the description by some unknown economic analyst of how he sees the current economic situation and Fed policy. My reaction, in that hypothetical, would be (1) this guy is really sharp and knows exactly what he's talking about (wish I could sign him up to write for Econbrowser!), and (2) he's honestly calling attention to the uncertainties in forming a forecast and policy prescription as to what comes next.
Can any reasonable person doubt that this is a particularly tricky time as the Fed tries to balance the threat of a significant economic slowdown (for which, if it occurs, the key factors are housing and energy prices) and a resurgence of inflation? Can any reasonable person doubt that, as it balances these threats, the Fed is not going to keep on raising interest rates forever? And can any reasonable person doubt that the Fed is going to want to gather all the information it can in determining exactly where to pause? To me, Bernanke is coming across as a very reasonable person, and I think the press makes a mistake if it continues to try to view him instead as the wizard behind the curtain.
So, is the Fed going to pause at 5%? I don't know, you don't know, the pundits don't know, and Bernanke himself doesn't know. It's going to depend on incoming data.
At least, that's what Bernanke said. So that's what I believe.
Posted by James Hamilton at May 2, 2006 08:08 PMdigg this | reddit
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My reaction, in that hypothetical, would be (1) this guy is really sharp and knows exactly what he's talking about (wish I could sign him up to write for Econbrowser!), and (2) he's honestly calling attention to the uncertainties in forming a forecast and policy prescription as to what comes next.
My reaction exactly and you said it very well. I guess after Greenspan people are just not used to hearing straightforward talk. That and the tendency for everyone to read into the oracle's statements what they want to hear.
Posted by: Anonymous at May 2, 2006 09:56 PM
An increase in interest rates is about the only short term policy move that could stop the increase of oil prices. Is it worth the fallout on the rest of the economy to go that way?
Posted by: Robert Schwartz at May 2, 2006 10:21 PM
Why assume an increase in interest rates will curtail gas prices? Short of starting a full blown world wide recession, a few more bps won't change the realities of the eneregy market.
The Fed cannot control geopolitical risk or demand from Japan, India and China. That's whats driving oil prices -- not low interest rates . . .
Posted by: Barry Ritholtz at May 3, 2006 03:18 AM
Ben needs to stop using idiots like Maria Bartiromo to convey Fed policy to the world. Maybe as he's new in the job he doesn't realize how everyone hangs on his every word. If he wants to chat up Maria at a cocktail party he should limit his chat to the weather, the Yankees, etc. If he wants to talk policy he should put out a press release or hold a press conference,and make it official. But dropping remarks to a foxy reporter will only cause confusion. Now people will never know when to take him seriously and when not. That's bad all around.
Posted by: jim miller at May 3, 2006 05:00 AM
One thing is for sure. Ben wont be drinking with Maria any more ...
Posted by: shark at May 3, 2006 05:17 AM
First, thank you for drawing attention to Bernanke's testimony. This stuff is very much worth reading in its own right, apart from any clues it might give about monetary policy.
I think perhaps Bernanke made an error in not putting in a sentence or two of explanation about the danger of instrument instability. Taken in isolation, the statement,
"... even if ... the risks ... are not entirely balanced ... the Committee may decide to take no action ... "
sounds quite dovish. I mean, what? Even if inflation is the bigger risk, they're still going to pause? Of course, if you look at the big picture -- long and variable policy lags, uncertainty in the impact of past and current policy, the particularly high economic uncertainty today, and so on -- and if you realize that the Fed will always have a later chance to catch up (e.g. a couple of 50 basis point hikes) if goes a little too slowly now, it's actually quite reasonable -- and not particularly dovish -- to think of pausing to get more information. But I can understand why not everyone saw it that way.
Posted by: knzn at May 3, 2006 07:08 AM
It is really a difference in desire. The street wants him to be an oracle and tell us what will happen and what they will do about it over the next year while he wants to lay out the uncertainties and avoid determinancy. Those are two different views of what transparency means. Clear as mud is not that clear.
Posted by: Lord at May 3, 2006 09:20 AM
I am surprised Bernanke is so sanguine about the inflation situation. Dave Altig's recent posting about inflation statistics suggest that things are getting out of hand.
He points to the so-called trimmed mean inflation measure, which eliminates the most extreme price changes, and has had the best track record over the past 15 years or so in predicting future inflation (even better than the traditional "core" inflation, which strips out food and energy).
The last three months this inflation measure has increased at annual rates of 2.6%, 3.5%, and 5.0%. That's a bad trend. Even if we look at year over year price changes, which inherently have much more inertia, the trimmed mean has climbed 2.7%.
The bottom line is that inflation has been bubbling up against the top of the Fed's "comfort zone" and now shows signs of bursting through the ceiling. This includes measures designed to smooth volatile inputs like energy, so oil and gas prices are not all that is going on here. These are strong signs of inflationary pressures which the Fed cannot afford to ignore.
In this situation I am surprised that Bernanke is taking such a "wait and see" position and I agree with those who are worried that he sees inflation as a lesser risk than recession.
Posted by: Hal at May 3, 2006 02:02 PM
This reminds me of the 1928-29 "policy normalization" that occured which was trying to control the out of control liquity of the 20's, but alas it was to late.
Much like now, it is to late. The damage has been done, nothing Bernanke can do to change it.
Posted by: Johnson at May 4, 2006 02:16 PM