WASHINGTON, July 17, 2013 — Federal Reserve Chairman Ben Bernanke’s comments today put him squarely in the camp of fiscal and monetary doves, signaling the Fed’s intention to keep interest rates low and money loose until their inflation and unemployment targets are met. His comments allayed fears that the Fed’s market stimulus would end soon, giving financial markets a late-morning boost.
Bernanke believes that the current inflation rate is too low and the unemployment rate too high to start reigning in the Fed’s bond purchases. The Fed will continue its policy of economic stimulus and continue to expand the money supply.
Bernanke opened his prepared remarks before the House Committee on Financial Services today with a pointed jab at fiscal hawks. He observed, “The economic recovery has continued at a moderate pace in recent quarters despite the strong headwinds created by federal fiscal policy.”
He said later in his remarks, “the risks remain that tight federal fiscal policy will restrain economic growth over the next few quarters by more than we currently expect, or that the debate concerning other fiscal policy issues, such as the status of the debt ceiling, will evolve in a way that could hamper the recovery.”
Bernanke’s remarks come against a backdrop of falling official unemployment rates. He noted that, “the unemployment rate stood at 7.6 percent in June, about a half percentage point lower than in the months before the Federal Open Market Committee (FOMC) initiated its current asset purchase program in September.” He had previously declared a target of 6.5 percent unemployment before raising the federal funds rate.
In his comments today, Bernanke declared, “if a substantial part of the reductions in measured unemployment were judged to reflect cyclical declines in labor force participation rather than gains in employment, the Committee would be unlikely to view a decline in unemployment to 6.5 percent as a sufficient reason to raise its target for the federal funds rate.”
That is, the Fed may continue to expand the money supply if they conclude that the drop in unemployment is due to people leaving the labor force rather than finding jobs. Bernanke’s testimony will yield scant comfort to those who have complained that Fed bond purchases represent an unwarranted and unprecedented expansion of the money supply, since he has raised the bar, or perhaps blurred it, for slowing that expansion.
Bernanke remains concerned by inflation rates that, by the measures used by the Fed, are too low. He noted, “consumer price inflation has been running below the Committee’s longer-run objective of 2 percent. The price index for personal consumption expenditures rose only 1 percent over the year ending in May.”
Bernanke’s concern is that low inflation rates will raise the real (inflation adjusted) cost of capital investment. His bigger fear is deflation. Falling prices can make businesses less willing to make capital investments, and also convince consumers to delay purchases of expensive durable goods — major appliances and cars, for instance — thus putting downward pressure on the economy. Japan’s decades of stagnation are the example favored by fiscal and monetary doves of the dangers of tight policy and deflation. It’s an example that haunts the dreams of economists like Paul Krugman, as well as Ben Bernanke.
Bernanke held out some hope for a tighter policy at the Fed. “I emphasize that, because our asset purchases depend on economic and financial developments, they are by no means on a preset course. On the one hand, if economic conditions were to improve faster than expected, and inflation appeared to be rising decisively back toward our objective, the pace of asset purchases could be reduced somewhat more quickly.”
In spite of comments like that, Bernanke’s statement focused on the dangers facing the economy. His concern that weakness in foreign economies will hamper growth in the United States was clear. The likelihood of continued loose policy was emphasized far more than the possibility of tightening that policy.
Bernanke emphasized again and again that the Fed will raise interest rates and reduce bond purchases only when inflation and unemployment targets have been met. He made that point crystal clear when he said, “In particular, the Committee anticipates that its current exceptionally low target range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent and inflation and inflation expectations remain well behaved in the sense described in the FOMC’s statement.” (Emphasis added.)
“At least as long.” Bernanke intends no substantial change to Fed policy until unemployment falls below 6.5 percent and seems likely to stay there, and only if inflation settles at 2 percent. Those conditions are unlikely to be met any time soon.
James Picht is the Senior Editor for Communities Politics and teaches economics and Russian at the Louisiana Scholars’ College in Natchitoches, La. After earning his doctorate in economics, he spent several years working in Moscow and the new independent states of the former Soviet Union for the U.S. government, the Asian Development Bank, and as a private contractor. He returned to Ukraine recently to teach principles of constitutional law and criminal procedure at several Ukrainian law schools for a USAID legal development project. He has been writing at the Communities since 2009.
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