Bernanke and irrational markets

March 1, 2012

Sometimes, markets just don’t make a lot of sense. Take Fed Chairman Ben Bernanke’s two-day testimony this week. Bernanke was his usual dovish self on Wednesday, emphasizing risks to U.S. growth and the likelihood of slow progress on bringing down the jobless rate. Yet global markets suddenly panicked, apparently because the Fed chief did not directly give any hints of imminent easing. It’s surprising that markets would be surprised by this, however, given that few expected any such signals.

On Thursday, however, stocks recovered their footing. By then, it was time for the bond market to use the old Bernanke excuse for a decent selloff of its own.

Yet the basic message in both days of testimony was that economic conditions are still not to the central bank’s liking and that further action does remain on the table. Bernanke’s lack of faith in the recovery is striking:

The decline in the unemployment rate over the past year has been somewhat more rapid than might have been expected, given that the economy appears to have been growing during that time frame at or below its longer-term trend; continued improvement in the job market is likely to require stronger growth in final demand and production. Notwithstanding the better recent data, the job market remains far from normal: The unemployment rate remains elevated, long-term unemployment is still near record levels, and the number of persons working part time for economic reasons is very high.

Household spending advanced moderately in the second half of last year, boosted by a fourth-quarter surge in motor vehicle purchases that was facilitated by an easing of constraints on supply related to the earthquake in Japan. However, the fundamentals that support spending continue to be weak: Real household income and wealth were flat in 2011, and access to credit remained restricted for many potential borrowers. Consumer sentiment, which dropped sharply last summer, has since rebounded but remains relatively low.

Markets also appeared to ignore a fairly strong statement from the Chairman in response to lawmakers’ concerns that low interest rates are punishing savers:

It is arguable that the interest are too high that they are being constrained by the fact that interest rates cannot go below zero. We have an economy where demand falls far short of the capacity of the economy to produce, we have an economy where the amount of investment and durable goods spending is far less than the capacity of the economy to produce. That suggests that interest rates in some sense should be lower than higher, we cannot make interest rates lower of course, only can go down to zero, and again I would argue that a healthy economy with good returns is the best way to get returns to savers.


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