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Bernanke Did Not Bomb



On Wednesday afternoon, April 27, 2011, Federal Reserve Chairman Ben Bernanke gave the first scheduled press conference by a Federal Reserve chairman immediately following a meeting of the Federal Open Market Committee (FOMC).  Chairman Bernanke was sure footed and appeared not to be surprised by any of the questions. He answered most of the questions directly, although, like any public official, he did not always answer the question precisely and sometimes declined to do so.

The press conference, indeed, was historic. But it was not the first by a Federal Reserve chairman. Paul Volcker had a press conference on October 6, 1979, after the FOMC's decision on the "New Operating Procedure" designed to defeat inflation. His predecessor Arthur Burns had two press conferences, but they were not post-meeting press conferences and only one was about FOMC policy—on Federal Reserve transparency. Alan Greenspan had several press conferences on trips to Japan in an effort to make sure that the Japanese press correctly interpreted his messages during his visit. However, regularly scheduled post-FOMC press conferences will now be routine—four times a year—and the Federal Reserve cannot easily go back. For the record, toward the end of the period when I was at the Federal Reserve (1972–98), I favored such a policy. I saw it as way to help to get the Federal Reserve's message across on a consistent basis.  The challenge will be when the FOMC and its chairman want to get out a clear message about a complex change in policy.

The single most important message on April 27 was on inflation.  If the Federal Reserve becomes convinced that inflation in the future is expected to increase significantly (inflation expectations in economist jargon), the FOMC will not hesitate to act even if unemployment is still high, he said. (Presumably how vigorous the action would be would depend in part on the level of unemployment at the time.) Chairman Bernanke also was clear that compared to conditions last fall there is a "narrowing tradeoff" between inflation and unemployment; the risk of deflation is now seen as much lower and the unemployment rate has come down somewhat.

He also argued that the effects of recent increases in energy and food prices are expected to be transitory and not contribute to underlying inflation.  The FOMC's new forecasts anticipate a sharp rise in the headline inflation rate for personal consumption expenditures (PCE) to 2.1 to 2.8 percent this year, up about a percentage point from the January forecasts. Although by 2013 the current projections converge to the range anticipated three months ago, there is some apparent pass through into the FOMC's projections of PCE inflation excluding food energy prices of about 3/10 percentage points in 2011 and 2012.

Bernanke gave a spirited defense of the effectiveness of the Federal Reserve's policy of purchases of long-term US government securities (known as the second quantitative easing or QE2). He argued that it has been effective in stimulating the economy, as had been expected. He sought to reassure markets that when the purchase program comes to an end at the end of June there will be minimal effects on interest rates and financial market conditions because the action has been anticipated and the effect on interest rates and other financial conditions has occurred through the reduction of the stock of those assets. Those effects should gradually wear off over time.

One unusual feature of this event, in contrast to testimony before the US Congress, was that Chairman Bernanke received three questions on the US dollar, 15 percent out of the total of 20 questions. He aligned himself with Treasury Secretary Timothy Geithner's statement on Tuesday, April 26, at the Council on Foreign Relations that "a strong dollar is in our interest as a country" and the United States will not embrace a strategy of trying the weaken its currency to gain economic advantage.  Bernanke inserted "and stable" after "strong" and added that this was in the "global interest." He linked his comment to the Federal Reserve's dual mandate of maximum employment and price stability—a healthy economy promotes a strong and stable dollar. In fairness, market participants in recent days appear not to be convinced that US policies will produce either a strong or a stable foreign exchange value of the dollar.

Bernanke addressed forcefully the core issue of US fiscal consolidation, but distinguished between the short run and the longer run. He endorsed, as he has before, the need for a credible long-term fiscal plan without going into details. He did not anticipate actions that would have negative effects on the economy in the short term.  However, he implied that if that were the course that the Congress and Administration chooses, it would affect Federal Reserve Policy consistent with its mandate. In other words, monetary policy would be easier than otherwise. In other words, it is important to get the balance between restoring fiscal balance and monetary balance right. Some would argue that a policy mix of all fiscal retrenchment and continuing monetary ease would weaken the dollar and distort the economy in the longer run.

In general, Bernanke nicely distinguished short-run from longer-run considerations both with respect to inflation and unemployment—though the distinctions may have been too subtle and unconvincing.  On the former, he said it is important to anchor long-term inflation expectations. On the latter, monetary policy can stimulate the economy and reduce unemployment -- long-duration unemployment as well as short-duration unemployment.  However, to the extent that the long-duration unemployment persists, the Federal Reserve's tools are limited in affecting it once the overall economy returns to normal, which he identified (according to the FOMC projections) with an inflation rate of slightly below 2 percent and an unemployment rate in the range of 5.2 to 5.6 percent.

Bernanke received no "existential questions" along the lines of what gives the Federal Reserve the right to do what it does—aside from the Federal Reserve Act. This was interesting in light of challenges to the Fed's legitimacy or mandate echoing in some parts of Congress these days, which may interest the Congress more than reporters. The closest to such a question was one on the large size of the Federal Reserve's balance sheet and the implications for inflation.  In answer to a question about the balance sheet, he appeared to dismiss the relevance of quantities (the amount of bank reserves) compared with interest rates and financial conditions as indicators of the stance of monetary policy.  This answer might be viewed as slightly inconsistent with his story about the channels for effects of large Federal Reserve purchases of US government securities, in which stocks or quantities matter.  Presumably, Professor Bernanke could have explained any perceived inconsistency, but there was no follow-up question that required him to do so.

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