Ben Bernanke on Inflation

Bernanke on Inflation: “Inflation Fighter”
A Daily Reckoning White Paper Report
by Mike “Mish” Shedlock, Whiskey & Gunpowder 

Some ideas are just too stupid to not comment on.

Hyping Ben Bernanke as an inflation fighter is one of those ideas. It’s not just one person who lost his mind, either. Both Tom Schlesinger, executive director of the Financial Markets Center, and Mark Zandi, chief economist, have simultaneously gone off the deep end in proposing that “Helicopter Drop” Bernanke is an “inflation fighter.” That absurd idea was proposed in a CNN/Money article about who will replace Greenspan as next Fed chairman entitled “Favorites Pull Ahead in Fed Derby.” Let’s take a look:

“Glenn Hubbard, the former chairman of the Council of Economic Advisers who is now teaching at Columbia, is also frequently mentioned as a strong candidate and viewed as less of an inflation hawk than Bernanke. Bernanke is seen as the long-time champion of explicitly pegging Fed interest rate moves to the rate of inflation.

“‘I would be nervous about picking an inflation-targeting champion as my next Fed chairman given the potential impact on employment growth,’ said Tom Schlesinger, executive director of the Financial Markets Center…

“‘No matter who is Fed chairman, they’re going to inflation target either explicitly like Bernanke wants to do or implicitly,’ said Zandi. ‘Someone without his inflation-fighting credentials might have to do more to win the markets’ trust of their inflation-fighting credentials.'”

That comment by Zandi is so stupid I just have to repeat it: “Someone without his inflation-fighting credentials might have to do more to win the markets’ trust of their inflation-fighting credentials.”

Bernanke on Inflation:Deflation Snips

Anyone who thinks Bernanke is an “inflation fighter” must not have read Bernanke’s most famous speech, “Deflation: Making Sure ‘It’ Doesn’t Happen Here.” Following are some “choice” snips from that famous speech:

“I am confident that the Fed would take whatever means necessary to prevent significant deflation in the United States and, moreover, that the U.S. central bank, in cooperation with other parts of the government as needed, has sufficient policy instruments to ensure that any deflation that might occur would be both mild and brief.

“Of course, we must take care lest confidence become overconfidence. Deflationary episodes are rare, and generalization about them is difficult…

“First, the Fed should try to preserve a buffer zone for the inflation rate, that is, during normal times, it should not try to push inflation down all the way to zero…

“Second, the Fed should take most seriously – as, of course, it does — its responsibility to ensure financial stability in the economy. Irving Fisher (1933) was perhaps the first economist to emphasize the potential connections between violent financial crises, which lead to ‘fire sales’ of assets and falling asset prices, with general declines in aggregate demand and the price level. A healthy, well-capitalized banking system and smoothly functioning capital markets are an important line of defense against deflationary shocks. The Fed should and does use its regulatory and supervisory powers to ensure that the financial system will remain resilient if financial conditions change rapidly. And at times of extreme threat to financial stability, the Federal Reserve stands ready to use the discount window and other tools to protect the financial system, as it did during the 1987 stock market crash and the Sept. 11, 2001, terrorist attacks.

“Third, as suggested by a number of studies, when inflation is already low and the fundamentals of the economy suddenly deteriorate, the central bank should act more preemptively and more aggressively than usual in cutting rates (Orphanides and Wieland, 2000; Reifschneider and Williams, 2000; Ahearne et al., 2002). By moving decisively and early, the Fed may be able to prevent the economy from slipping into deflation, with the special problems that entails.

Bernanke on Inflation:Reversing Deflation

“As I have indicated, I believe that the combination of strong economic fundamentals and policymakers that are attentive to downside as well as upside risks to inflation make significant deflation in the United States in the foreseeable future quite unlikely. But suppose that, despite all precautions, deflation were to take hold in the U.S. economy and, moreover, that the Fed’s policy instrument — the federal funds rate — were to fall to zero. What then? In the remainder of my talk, I will discuss some possible options for stopping a deflation once it has gotten under way…

“As I have stressed already, prevention of deflation remains preferable to having to cure it. If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation.

“So what then might the Fed do if its target interest rate, the overnight federal funds rate, fell to zero? One relatively straightforward extension of current procedures would be to try to stimulate spending by lowering rates further out along the Treasury term structure — that is, rates on government bonds of longer maturities. There are at least two ways of bringing down longer-term rates, which are complementary and could be employed separately or in combination. One approach, similar to an action taken in the past couple of years by the Bank of Japan, would be for the Fed to commit to holding the overnight rate at zero for some specified period. Because long-term interest rates represent averages of current and expected future short-term rates, plus a term premium, a commitment to keep short-term rates at zero for some time — if it were credible — would induce a decline in longer-term rates. A more direct method, which I personally prefer, would be for the Fed to begin announcing explicit ceilings for yields on longer-maturity Treasury debt (say, bonds maturing within the next two years). The Fed could enforce these interest-rate ceilings by committing to make unlimited purchases of securities up to two years from maturity at prices consistent with the targeted yields. If this program were successful, not only would yields on medium-term Treasury securities fall, but (because of links operating through expectations of future interest rates) yields on longer-term public and private debt (such as mortgages) would likely fall as well…

“The Fed can inject money into the economy in still other ways. For example, the Fed has the authority to buy foreign government debt, as well as domestic government debt. Potentially, this class of assets offers huge scope for Fed operations, as the quantity of foreign assets eligible for purchase by the Fed is several times the stock of U.S. government debt…

“Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation…

“I hope to have persuaded you that the Federal Reserve and other economic policymakers would be far from helpless in the face of deflation, even should the federal funds rate hit its zero bound.”

Mish, that article was from 2002 do you have anything more current?

Well that’s a good question, but if I critiqued every silly thing Bernanke has said since 2002, we just might be here for a while. That said, inquiring Mish readers deserve answers, so let’s look at a couple of recent articles about Bernanke.

Bernanke on Inflation: “The Fed’s Wild Imagination”

In “The Fed’s Wild Imagination,” Kurt Richebacher takes apart Greenspan’s and Bernanke’s views on the “global savings glut” theory:

“In his testimony to Congress on July 20, 2005, Mr. Greenspan declared it quite likely that the world is currently experiencing a global savings glut. Agreeing with Ben Bernanke, he mentioned this glut as one of the factors behind the so-called interest conundrum, i.e., declining long-term rates despite rising short-term rates.

“Having read a lot from the Fed’s luminaries, their inability to distinguish between rampant global credit excess and a global savings glut does not surprise us. In this view, the Federal Reserve has come to the rescue of a world where excessive saving is threatening depression by eliminating savings.

“Attracted by superior rates of return on U.S. assets, investors around the world have been scrambling to pour their excessive savings into direct investments, stocks, bonds, and real estate in the United States, in this way financing the resulting huge U.S. trade deficit.

“While this explanation may seem to make sense, there is one big snag: Not one word of it is true. First of all, in reality, private foreign investors have drastically curbed their investments in the United States. According to the Bank for International Settlements — the international organization of the world’s central banks — Asian central banks financed 75% of the U.S. current account deficit in 2004.

“First, private capital flows into the United States have slumped. Without the massive interventions by the Asian central banks, the dollar would have collapsed long ago.

“Second, the dollars with which these central banks have been buying U.S. Treasury and agency bonds have definitely nothing to do with Asian savings. Evidently, the central banks are recycling the dollars, no more, no less, which they receive from U.S. trade and capital flows. These dollars have come into the central banks’ possession through their interventions in the currency markets, to prevent a rise of their currencies against the dollar.

“To speak of a global savings glut as a possible cause of the surprisingly low U.S. long rates in the face of these blatant facts is truly the height of insolence and absurdity. That this opinion comes from the leading figures of the Federal Reserve is more than shocking.”

Here is what Bernanke was saying on Tuesday, Oct. 11, 2005, as reported by Reuters in “More Asia FX Flexiblity Needed”:

“White House economic adviser Ben Bernanke said on Tuesday greater currency flexibility in Asia and stronger economic growth among U.S. trading partners were needed to help reduce global trade imbalances…

“He also told the group that while energy prices were pushing up U.S. inflation, it did not appear they were having much of a spillover impact on so-called core prices.”

Anyone that thinks that a higher RMB is going to solve the United States’ trade gap with China is point-blank nuts. For starters, it would push up the price of goods coming from China, thereby causing inflation. Secondly, at 20-1 wage differentials between China and the United States, it will not bring back jobs to the United States or by itself restore the trade balance, either. For the record, I actually agree with Bernanke that energy prices are not having too much of a spillover effect on the economy, but that certainly is not the view of inflation-fighting hawks.

Two dark horse candidates in the race to replace Greenspan are said to be current Fed governors Roger Ferguson and Donald Kohn, according to this article entitled “Greenspan Chooses a Successor”:

“Both are highly skeptical of Bush’s tax cuts, despite the strong economic recovery the cuts have spurred. Both could be expected to continue raising interest rates, in part to punish the president for not raising taxes and failing, in their view, to pay enough attention to the budget deficit. Their likely idea of a tacit deal next year with the White House: You raise taxes, we’ll stop boosting rates.”

If that is true, does anyone think this president would appoint either of them?

Martin Feldstein, the president of the National Bureau of Economic Research, is seen as an almost co-favorite with Bernanke, but given Feldstein’s position as a director of the scandal-plagued American International Group, as well as his likely political independence as compared to Bernanke, the choice may be a foregone conclusion.

There you have it folks, $Ben Bernanke, IFE — “Inflation Fighter Extraordinaire” — is the odds-on next Fed chairman simply because he will likely be the loosey-goosey, free-for-all Bush suck-up this administration wants, and no other candidate has those exact qualifications. I hope I am wrong. If I am wrong, it will be neither the first nor the last time. If I am right, please remember this: $Ben is gold’s best friend.

Mike Shedlock / Mish

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Related Links onBernanke on Inflation:

The Federal Reserve Board – Ben S. Bernanke was sworn in on February 1, 2006, as Chairman…
Wikipedia – Ben Bernanke
MSNBC – “Ben Bernanke sworn in as 14th Fed chairman.”
CNN Money – What will incoming Federal Reserve chair Ben Bernanke do at his first monetary policy meeting on. – Betting on Ben: FOUR years ago, Ben Bernanke was a professor of economics at Princeton whose policy making experience consisted of a stint on the local school board.


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