Bernanke drops a D-bomb
By James Saft
(Reuters) – Ben Bernanke dropped a D-bomb on Congress on Wednesday.
And no, though much of his testimony arguably depicted lawmakers as dumb, ‘D’ in this context stands for deflation.
“The (Federal Open Market) Committee is certainly aware that very low inflation poses risks to economic performance – for example, by raising the real cost of capital investment – and increases the risk of outright deflation,” Bernanke told the House of Representatives Financial Services Committee.
“Consequently, we will monitor this situation closely as well, and we will act as needed to ensure that inflation moves back toward our 2 percent objective over time.”
A look at the bond market shows investors immediately moving in the moments after he spoke to re-price downward the risk that the Fed actually will begin to slow, or taper, its bond purchases in coming months. Ten-year Treasury yields fell from 2.55 percent just before he spoke to as low as 2.46 percent, while 2-year yields fell proportionally four times as much, touching just 0.30 percent.
That makes sense: a Fed eyeing, and warning about, deflation is not a Fed in a position to ease up on the monetary gas pedal.
And though Bernanke has put much effort into making a distinction between slowing asset purchases and actually raising interest rates, both amount to a tightening of monetary conditions, the last thing needed if deflation threatens.
Deflation, a general fall in prices over time, is a particularly difficult phenomenon for central bankers. Not only does it encourage households and businesses to put off purchases and investments, but because this has a self-reinforcing effect it can be hard for even extraordinary monetary policy to combat.
Rising gasoline prices drove a 0.5 percent increase in U.S. consumer prices in June, data showed on Wednesday, but core inflation rose just 0.2 percent for the month and 1.6 percent over a year, the smallest increase in two years.
Nonetheless, Bernanke took pains to keep his options open, saying asset purchases could be slowed “somewhat more quickly” if things went well, or maintained longer or increased if need be.
While outright deflation is a bit of a nightmare for investors, a Fed willing to fight it strongly is a huge bonus. Not only will continued bond purchases help to fend off the bear market in bonds which seemed to be shaping up, they will help to support equity prices.
D IS FOR…
The Fed’s job is being made much harder by a political process which is turning out particularly bad policy. Not only is the pace of government spending acting as a brake on growth, but a lack of a clear strategy for long-term deficit reduction means, all else being equal, that like as not we’ll be in a similar or worse position in several years’ time.
Bernanke said growth faces “strong headwinds created by federal fiscal policy,” which “makes a big difference” for jobs and unemployment.
“My suggestion to Congress is to consider policies that involve somewhat less restraint in the near term,” he said, also calling out Congress for not adequately addressing long-term issues such as social security and other benefits.
Perhaps Bernanke was so plain spoken because this may well end up being his last semi-annual Humphrey Hawkins testimony, as most expect him to leave the Fed at the expiration of his current term in January.
Bernanke is someone who made his academic reputation studying the tragedy of the last depression, namely that policy didn’t move rapidly or forcefully enough. He learned that lesson well, and no one can fault him for a lack of daring or creativity in monetary policy. He’s overseen an unprecedented expansion of the Fed’s balance sheet and the introduction of a host of innovative, but unproven, other policies.
Unfortunately, there isn’t great evidence at this point that it is working, if we define working as doing more good than harm. Extraordinary monetary policy has certainly been good for risky assets and those of us who make their livings off of them, but the economy remains curiously sluggish, with an increasing gap between rich and poor and little evidence of the kind of steady growth in living standards we saw before the growth of financialization.
That may turn out to be the tragedy of the Bernanke era. Not that he did too much during the panic years of 2008 and 2009; it is hard to blame him for that.
Rather, that a failure by the rest of government to address the long term without cutting the economy off at its knees in the short term forced the Fed to stick with risky, and perhaps ultimately counter-productive, policies for too long.
Perhaps in the end, Bernanke, nice guy that he is, dropped the wrong D-bomb on Congress.
(James Saft is a Reuters columnist. The opinions expressed are his own)
(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at firstname.lastname@example.org and find more columns at blogs.reuters.com/james-saft)
(Editing by James Dalgleish)