Thursday, April 28, 2011

How the Inflationistas Have Shaped Fed Policy

Ben Bernanke's press conference yesterday seems to have left observers with one crucial take-away. As noted by Tim Duy:
The most interesting comments came in response to questions about whether the Fed should do more to lower unemployment and if QE2 is effective, shouldn’t the program continue? Here was a more hawkish Bernanke. As I noted earlier, growth forecasts returned to the pre-QE2 range, which should be a red flag. Unemployment remains high, with only moderate job creation. Core-inflation remains low, while the impulse from commodity prices on headline inflation is expected to be temporary. ...So why not do more? Because the Fed needs “to pay attention to both sides of the mandate” and the “tradeoffs are less attractive.”

Apparently the threat of headline deflation off the table, Bernanke is not inclined to pursue sustained easing despite low core inflation and high unemployment.
Numerous observers (see e.g. Mark Thoma, Brad DeLong) have noted that any concern about inflation by the Fed right now is a bit ridiculous. In fact, the more "hawkish" Bernanke on the topic of further expansionary actions by the Fed seems at odds with the Fed's own data and projections. Most significantly to me, it also seems at odds with Bernanke's remarkably detailed and perceptive explanation of exactly why he finds the long-term unemployment problem to be so very "distressing":
BERNANKE: You're absolutely right. Long-term unemployment in the current economy is the worst, really, the worst it's been in the post-war period. Currently, something like 45 percent of all the unemployed have been unemployed for six months or longer. And we know the consequences of that can be very distressing, because people who are out of work for a long time, their skills tend to atrophy; they lose contacts with -- with the labor market, with their other people working, the networks that they have built up. Very concerning.
These are not the remarks of someone who doesn't care about the plight of the unemployed. And this not is the sort of detailed description of the permanent harm that unemployment wreaks on individuals that we would typically expect from someone who's principally worried about inflation. So why the talk about the potential dangers of inflation?

I believe that Bernanke's references to the Fed's "dual mandate", and most importantly, the hard reality confirmed in this press conference that there will be no further easing by the Fed, are the direct result of politics, not economics.

The noise that has been generated about the Fed's expansionary actions over the past 3 years is substantial, and has only gotten louder in recent months. This has not gone unnnoticed within the Fed. Some loud voices in the business press, as well as many prominent politicians (mostly Republican), have been squawking incessantly about the awful dangers (imaginary though they may be) of the Fed's expansionary policies. And I think that this, unfortunately, has had a direct impact on Fed policy. I think that there are genuine concerns at the Fed about its reputation and its independence, and that protecting both of those has forced Bernanke into the position of acknowledging the concerns of the Fed's critics, even though from a purely economic perspective they are absolutely misguided.

In short, I believe that we are seeing a Fed that is sensitive to the political winds swirling around its actions, and that the inflationistas out there have had a real impact on Fed policy -- not because they have good economic arguments, but because they have a frightening amount of political power. And perhaps that should be the most concerning thing of all.


  1. Vilvos Gay6:58 PM

    Came here from Krugman's piece. I totally agree.

  2. bakho7:22 PM

     Why should the Fed go further  out on a limb if Congress is going to respond by contractionary fiscal policy?

    Maybe the Fed is better off keeping its powder dry and discouraging fiscal contraction?

    The Fed needs fiscal policy to pull in the same direction or at least not oppose its efforts. 

    The politics surrounding economic policy are toxic and preventing rational policy making.

  3. Steve Dwight10:45 PM

    "many prominent politicians (mostly Republican), have been squawking incessantly about the awful dangers... of the Fed's expansionary policies."

    Yes, the danger is that we might have an expanding economy... in 2012.  Very bad for GOP presidential candidate.

  4. PeakVT1:18 AM

    <span>Why should the Fed go further  out on a limb if Congress is going to respond by contractionary fiscal policy? </span>

    That makes no sense.  The House isn't exactly tuning the fine details of the budget based on the FRB's policies.  The loons current running the place have an ideology and it's been driving their actions regardless of facts.  And they're the reason we're talking about QEII and QEIII and QEMCLXXIV and so on.  The FRB is the only institution that can act to try to lower unemployement.  But it won't.

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