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July 2024

Overconfident Ben Bernanke

In the following video, Ben Bernanke answers questions from Paul Ryan (R-WI). Paul asked some really sensible questions. Bernanke remains largely too confident. This is generally not a good sign.

Allan Meltzer, a historian specialized in the Federal Reserve system, in the following WSJ piece, shares his historical view on the Fed and inflation outlook. He thinks Bernanke Fed will put us on another “70s show”.

In the 1970s, despite rising inflation, members of the Federal Reserve’s policy committee repeatedly chose to lower interest rates to reduce unemployment. Their Phillips Curve models, which charted an inverse relationship between unemployment and inflation, told them that inflation could wait and be addressed at a more opportune time. They were flummoxed when inflation and unemployment rose together throughout the decade.

In 1979, shortly after becoming Fed chairman, Paul Volcker told a Sunday talk-show audience that reducing inflation was the best way to reduce unemployment. He abandoned the faulty Phillips Curve thinking that unemployment was the enemy of inflation. And he told the Fed’s staff that while he thought highly of their work, he did not find their inflation forecasts useful. Instead of focusing on near-term output and employment, he changed the Fed’s policy to put more emphasis on the longer-term reduction of inflation. That required a persistent policy that President Reagan supported even in the severe 1982 recession.

We know the result: Inflation came down and stayed down. The Volcker disinflation ushered in two decades of low inflation and relatively steady growth, punctuated by a few short, mild recessions. And as Mr. Volcker predicted, the unemployment rate fell after the inflation rate fell. The dollar strengthened.

That was not unprecedented. The Phillips Curve often fails to forecast correctly. Spanish inflation has increased in the last year while the unemployment rate rose above 20%. Britain also has rising inflation and rising unemployment. Brazil lowered inflation and unemployment together. There are many other examples if only the Fed would look at them.

Throughout its modern history, the Fed has made several of the same policy mistakes repeatedly. Two are prominent now. It concentrates on near-term events over which it has little influence, and neglects the longer-term consequences of its operations. And it interprets its dual mandate as requiring it to direct all of its efforts to reducing unemployment when the unemployment rate rises. It does not have a credible long-term plan to reduce both current unemployment and future inflation, so it works on one at a time. This is an inefficient way to achieve a dual mandate. It failed totally during the Great Inflation of the 1970s. I believe it will fail again this time.

Commodity and some materials prices have increased dramatically in the past year. Countries everywhere face higher inflation. Despite the many problems in the euro area, the dollar has depreciated against the euro, a weak currency with many problems, suggesting that holders expect additional dollar weakness. Imports will cost more.

I believe it is foolhardy to expect businesses to absorb all the cost increases by holding prices unchanged. And loan demand has started to pick up, increasing the amount of money in circulation. It is a big mistake to expect that the U.S. will escape the inflation that is now rising throughout the world.

Because the Fed focuses on the near term, it tends to ignore changes in money-supply growth. This, too, is a mistake. Sustained inflation always follows increases in money-supply growth. Sustaining negative real interest rates (i.e., adjusted for inflation), as we have now, will cause this.

The Fed should make three changes. First, it should increase the short-term interest rate it controls to 1%, which would show that it is aware of the inflation risk and will act promptly to counteract it. Current low interest rates are an opportunity for the Fed to start reducing excess reserves.

Inside FOMC

Rick Mishkin talks about the decisions made during the Fed’s recent meeting.

Greenspan on current state of economy

A few interesting points to note:

1. (this is not new in his thinking) It’s not only real economy that drives equity market: but also it’s the other way around: equity market also drives real economy. The channel is stock prices help ratings of corporate debt.

2. He is very worried about US fiscal situation;

3. China is a bubble waiting to burst. But the impact will be uncertain.

Hawks and doves inside the Fed

FT dissects the Fed:


Janet Yellen, president, San Francisco Federal ReserveVote

Leading dove on the committee. A heavyweight former senior economic adviser in the Clinton White House who recently joined the Group of 30 leading global policymakers. Expects the recovery will “look something like an L with a gradual upward tilt”. Believes the output gap exerts the dominant influence on prices and that “economic slack and downward wage pressure are pushing inflation below rates that are consistent with price stability”

Eric Rosengren, president, Boston Fed No vote

Has a special interest in the problem of banks “too big to fail”. Thinks the recovery is “quite capable of falling short” of market expectations. Like Ms Yellen, is worried about inflation falling too low and fears premature tightening. Says rate policy should be based on the understanding that, “We need the economy to grow rapidly enough that unemployment falls substantially and inflation settles at a rate near 2 per cent”


Donald Kohn, vice-chair, Federal Reserve boardVote

The most influential figure after chairman Ben Bernanke, Mr Kohn is an anchor against pressure from hawks. Defends the dual mandate, and a focus on core inflation and the output gap, saying the Federal Reserve act requires the Fed to consider the “level of output relative to the economy’s potential” alongside the inflation rate. Thinks “the persistence of economic slack” will keep inflation subdued and worries about inflation falling too low

William Dudley, president, New York Fed Vote

Succeeded Tim Geithner as head of the New York Fed, a pivotal position in the system. Sees a recovery “less robust than desired” because of headwinds from the banking sector. Distinguishes sharply between the “how” and “when” of exit strategy, and stresses that the Fed’s preferred option is not to sell its portfolio of assets back into the market. Says, “We face meaningful downside risks to inflation over the next year or two”


Ben Bernanke, chairman, Federal Reserve boardVote

The chairman defines the centre of the committee and fashioned the radical “credit-easing” strategy that is now winding down. Shares the doves’ belief that there is a large output gap that will put considerable downward pressure on inflation but puts more emphasis on inflation expectations as an autonomous factor. Last year edged the Fed away from an exclusive focus on core inflation; is not indifferent to dollar weakness

Daniel Tarullo, governor, Federal Reserve boardVote

An Obama appointment with close ties to the White House, he is an expert on regulation and leads the Fed’s overhaul of financial supervision including bankers’ pay. Has not taken sides in the debate over monetary policy. Says pay should be viewed as a “safety and soundness” issue, and wants to avoid a “formulaic approach” to achieving this. Favours stronger capital and liquidity requirements for banks and more co-ordinated bank supervision

Elizabeth Duke, governor, Federal Reserve boardVote

The former banker has remained relatively quiet in public on monetary policy, though she is an influential voice on the banking sector and credit trends. A few months ago she judged that the “decline in lending is not tremendously large relative to the experience of past business cycle downturns” and that the credit crunch was less intense than that of the 1990-91 recession thanks to massive policy interventions

Charles Evans, president, Chicago FedVote

Has gone further than others in putting a time frame on the first rate rise – “most likely to be towards the end of 2010/11” – though that assessment is not set in stone. Gives weight to the output gap and inflation expectations. Says “resource gaps remain substantial today. That’s a significant mitigating factor against inflation pressures”. Also sees inflation expectations as a “powerful determinant of inflation”, the stability of which cannot be taken for granted

Dennis Lockhart, president, Atlanta FedVote

Centrist leaning recently towards the dovish, with fears about the underlying strength of the recovery. Notes that “both the data and anecdotal descriptions of ground-level reality are quite mixed”, with foreclosures, unemployment, income and bank failures continuing “to disappoint”. Is “particularly concerned about interaction among bank lending, small business employment” and commercial property, with small businesses reliant on credit from troubled banks

Sandra Pianalto, president, Cleveland FedNo vote

A centrist with dovish tendencies, she says: “We have a lot of ground to make up before we even get back to the levels of output seen in 2007”. Sees “considerable slack” and “tangible evidence” that this will help keep inflation subdued. But still sees the inflation outlook as “uncertain”. Why? Inflation concerns relating to the Fed’s swollen balance sheet “must be taken seriously” even if policymakers think these concerns are misplaced

James Bullard, president, St Louis FedNo vote

Centrist leaning towards the hawkish, says uncertainty over inflation is “as high as it has ever been since 1980”. Still sees a lingering deflation risk but, beyond that, an inflation risk. An independent thinker, he shares some positions with doves and some with hawks. Has little time for output-gap analysis – thinks the Fed should start tightening as soon as strong job growth resumes. Favours selling assets rather than raising rates to begin with

Narayana Kocherlakota, president, Minneapolis FedNo vote

Newcomer who took office only last month. No policy views yet expressed


Kevin Warsh, governor, Federal Reserve boardVote

The DC Fed’s ambassador to Wall Street, he puts more weight than others on the upswing in financial markets as a “forward-looking sign of growth and inflation prospects”. Is optimistic about a “positive feedback loop” between market strength and economic activity, but is watching asset prices carefully. Warns against waiting until the economy is back to normal before raising rates and says when the Fed tightens it may have to do so rapidly

Richard Fisher, president, Dallas FedNo vote

Former über-hawk, moving towards the centre. Thinks the recovery will look like “a check mark” with a slope “that is less than desirable and might possibly be repressed by an occasional pause”. Worries that businesses will be slow to start hiring again. Says “inflation is likely to remain subdued for a time” but fears Fed guidance on rates may be fuelling the dollar carry trade, which could end in a disorderly adjustment in asset markets


Charles Plosser, president, Philadelphia FedNo vote

Thinks “the good news will increasingly outweigh the bad news” on growth and views unemployment as a “lagging indicator”. Sees little near-term risk of inflation but “greater risk of high inflation in the intermediate to long term”. Deeply sceptical about output gaps; says the crisis has hit potential output as well as demand. Troubled by the Fed’s interventions in private credit markets and wants to get back to more rules-based policy

Jeffrey Lacker, president, Richmond FedVote

Prioritises inflation expectations and is sceptical about output-gap analysis – which he says “greatly underestimated inflation” in the 1970s. Fears ongoing Fed asset purchases will push bank reserves beyond desired levels at which point policy will become much more stimulative. Sees inflation as medium-term risk and wants Fed to tighten “when growth becomes strong enough and well enough established” – but admits it is not certain that this will come in 2010

Thomas Hoenig, president, Kansas City FedNo vote

Was first to raise the need for the Fed to tighten in a timely fashion in June, with the words “as the economy begins to recover, even at a modest pace . . . the current level of monetary accommodation will need to be withdrawn”. Concerned about banks “too big to fail”. Worries about excess reserves and appears keen to get away from near-zero rates. Says “moving from zero to one per cent, for example, is not tight policy”

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