I've been having a spirited twitter discussion with the Economist's Ryan Avent, who is better-versed than I in Fed-speak. He's brought up several points of clarity on Fed Chair Ben Bernanke's disappointing speech this morning.
Avent's takeaway is that the Fed will adopt more aggressive policies if economic indicators this fall don't match forecasters' predictions; it's not clear to me that is what the typically opaque speech signifies -- "should further action prove necessary, policy options are available to provide additional stimulus ... the Committee will certainly use its tools as needed to maintain price stability -- avoiding excessive inflation or further disinflation -- and to promote the continuation of the economic recovery" -- but observers had the impression for some time that Bernanke could do more and would if the situation grew dire enough. The unaddressed question has been this: What are his, and the broader Fed's, criteria for deploying these tools? The answer wasn't apparent in the speech, except that Bernanke rejected explicit inflation targeting.
Avent's other worthwhile point is that, while current measures of the price level are in fact deflationary, Bernanke worries as well about long-term inflation expectations. Right now, though, expectations are well below recent historical average, with the 10-year expected inflation sitting at 1.68 percent:
Which is why I was disappointed to here another Fed speech where the primary problem identified is inflation -- if anything, we're trending toward deflation -- to the detriment of the real problem we're facing: unemployment and flagging growth. Bernanke's speech was a failure because he didn't provide a convincing answer to the question, "Why is maintaining lower-than-average inflation expectations over a 10-year window more important than addressing current problems of unemployment and lagging growth?" You get the sense that he doesn't have one but feels the internal and external politics of the Fed require him to soft-pedal his preferred policies.
The speech also highlights the importance of approving the president's nominees to the Fed's Board of Directors. A divided Fed settled on the status quo at their last meeting a few days ago, and now the institution is afraid to shift position in advance of its next meeting for fear of setting off a panic. Had stronger voices identified the actual problems in the economy and set about solving them, perhaps we would not wait another six weeks before (hopefully) adopting the right policies for the economy.
-- Tim Fernholz
