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A public policy blog from AEI
Listening to Capital Hill Republicans grill Ben Bernanke yesterday and today, one might think they were questioning and criticizing some 1970s-era Fed chairman such as Arthur Burns or William Miller. Prices rose at an annual 7.5% clip when those guys ran the show. Here are a few reality-check data points for the GOP:
1. Annual inflation has averaged 2% since Ben Bernanke became boss of the US central bank, the lowest average inflation of any Federal Reserve chairman’s tenure since the Great Depression. Bernanke himself noted this in responding to a statement by Senator Bob Corker, a Tennessee Republican.
2. Over the past year, US consumer prices have risen by less than 2% — 1.6%, as measured by the Labor Department’s consumer price index, 1.9%, as measured by the Commerce Department’s personal consumption expenditures prices index.
3. The Federal Reserve Bank of Cleveland reports that its latest estimate of 10-year expected inflation is a skimpy 1.5%.
4. Long-term Treasury rates are under 2%.
The GOP should have been hammering Bernanke on the economy’s meager growth and job creation since the Great Recession.
But they strangely seem more concerned about 2% inflation than 8% unemployment. Economist Scott Sumner:
A policy of ultra-low inflation during a period of very high unemployment is shameful, and indeed violates the Fed’s mandate to focus on both employment and price stability. The Fed is supposed to run below average inflation during booms and above average inflation during recessions. Indeed they are legally required to do so!
So we have Bernanke essentially bragging that he broke the law and helped create mass unemployment, because it’s his only way of defending himself against those Senators who want him to break the law even more egregiously—to create even lower than post-war record low inflation in order to create even higher unemployment.
Inflation is always and everywhere a monetary phenomenon — but not everywhere and always a big problem. Indeed, those low, low interest rates signal monetary policy is too tight, not too loose. As Milton Friedman once put it: “After the U.S. experience during the Great Depression, and after inflation and rising interest rates in the 1970s and disinflation and falling interest rates in the 1980s, I thought the fallacy of identifying tight money with high interest rates and easy money with low interest rates was dead. Apparently, old fallacies never die.”
At least not on Capitol Hill. So concerned are Republicans about inflation that they are pushing a bill which would strike “maximum employment, stable prices” from the Federal Reserve Act and instead insert “maximum employment by means of long-term price stability.” This would, in effect, narrow the Fed dual unemployment-inflation mandate to focus the Fed even more on inflation.
About the only good thing Republicans might be doing right now when it comes to monetary policy is accidental. By talking up the inflationary potential of the Fed’s enlarged balance sheet, they may eventually raise inflationary expectations. Economist David Beckworth once cheekily suggested policymakers do just that.
The Fed’s balance sheet, then, currently appears to be anything but a problem with regards to inflation. Now, someday it could be a problem, but right now it is not and that indicates the Fed is failing in its efforts to stabilize spending–the one thing the Fed can and should be doing.
Now, since the Fed’s balance sheet is not currently a problem, it actually has the potential to be useful. In fact, it presents a great opportunity to help change inflationary expectations and thus stabilize spending. How so? By publicly acknowledging the inflationary potential of the Fed’s expanded balance sheet. Yes, this seems contrary to what I just wrote above, but that is exactly why it needs to be done. If enough public officials and other influential observers express concern about the Fed’s balance sheet being inflationary and do it repeatedly, then the public will become concerned too. Inflationary expectations will then increase and will thus lower current real interest rates, decrease the demand for money (i.e. increase velocity), and improve the outlook for the troubled household balance sheets (by increasing future asset values). Now, inflationary expectations could overshoot using this approach and there are better ways to stabilize expectations, like having the Fed explicitly commit to an inflation, price-level, or nominal GDP target.
The GOP push for spending cuts will work best economically if the Fed is running a loose monetary policy. The Beckworth Gambit aside, if markets perceive all this GOP cajoling as raising the odds of the Fed ending early its bond-buying policy and/or raising interest rates, the result could be an immediate passive tightening of monetary policy. (Indeed, that may already be happening.) More broadly, the GOP seems suck in the 1980s when it comes to the Fed, monetary policy, and inflation.
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