Someone once heard Bernanke’s Grandmother say: “Ben, it’s not good to lie.” The same person heard Bernanke say: “What does she know about business?”
By Greg Robb, from MarketWatch
WASHINGTON (MarketWatch) – Federal Reserve Board Chairman Ben Bernanke stuck his neck out on Tuesday and said the increase in inflation from the spike in oil prices will be modest and temporary.
“The most likely outcome is that the recent rise in commodity prices will lead to, at most, a temporary and relatively modest increase in U.S. consumer price inflation,” Bernanke said in remarks to the Senate Banking Committee.
Bernanke, appearing before Congress for his twice-a-year testimony on monetary policy, has been trying to throw cold water on market fears about inflation. The Fed believes that if these fears get out of hand, it can be a self-fulfilling prophesy for higher inflation.
Consumers and lawmakers have criticized the Fed as gasoline prices have surged – averaging $3.37 per gallon at the pump, up from $2.70 a year ago, according to AAA.
“The breadth of commodity prices increases has been stunning,” said Sen. Patrick Toomey, a freshman Republican Senator from Pennsylvania.
The increase reminds economists of gasoline prices in the wake of Middle East turmoil in the 1970s, though energy now eats up a smaller proportion of the typical American consumer’s wallet.
Financial markets were already worried that the Fed would not be able to exit its ultra-easy monetary policy without sparking inflation. The rise in oil prices has exacerbated that concern.
On Wall Street, stock prices sank as investors digested Bernanke’s testimony and answered senators’ questions, with the Dow Jones Industrial Average (DOW:DJIA) surrendering most of its Monday gains by early afternoon. The cline was attributed more to another rise in oil prices.
Sen. Jim DeMint, a Republican from South Carolina, added that Fed’s monetary policy easing “has caused some concern about the long-term value of our currency and has caused a lot of us to look at ways to create more soundness to our monetary policy.”
Bernanke issued a strong defense of the Fed’s innovative bond-buying program and insisted that supply and demand factors, and not Fed policy, was behind the run in commodity prices (BOARD:CRY00). He specifically said the weaker dollar (BOARD:DXY) was not behind the surge in commodity prices, since commodity prices have climbed significantly in terms of all major currencies.
At the same time, Bernanke tried to reassure markets that he would be watchful in case he turned out to be incorrect.
“We will continue to monitor these developments closely and are prepared to respond as necessary to best support ongoing recovery in a context of price stability,” he said.
Later on, he said the Fed was “unwaveringly committed” to low and stable inflation.
Fed officials have fanned out in recent days to discuss the central bank’s policy stance, and even the most dovish of these officials have said they would not tolerate a sustained increase in inflation.
Indeed, from their perspective, inflation is not here yet: Consumer prices, as measured by the personal consumption expenditure index, rose at a 1.2% year-on-year rate in January. This is well below the Fed’s implicit target of 2% or a bit below.
Core prices are even lower, only up at a 0.8% year-on-year rate. Core prices, which exclude food and energy input, are closely monitored as a way to see if rising prices are being passed along.
For his part, Bernanke said that the cost pressures from higher fuel and gas prices are being offset by stable wages. Bernanke told the Senate panel there was good news on deflation, one of the Fed’s biggest concerns last summer and fall.
With the economy so weak and inflation running so low, there was danger that the economy would slip into a period of steady falling prices. This could have crippled the economy because deflation, among other things, makes consumer debt more expensive.
But now, “deflation risks have greatly declined,” Bernanke said.
Some economists are also worried that rising gas prices will negate the positive stimulus expected from the payroll-tax cut that took effect this year. The few extra dollars of take-home pay will only go to fill up fuel tanks instead of boosting spending on goods and services, this line of reasoning goes.
Some, like ex-White House economic advisor Christina Romer, argue that the economy could benefit from another round of Fed bond purchases – a strategy known as quantitative easing – when the current $600 billion program ends. But in his testimony Tuesday, Bernanke didn’t show his hand about prospects for any additional quantitative easing.
He issued another strong defense of the bond purchases made to date, saying that one of the benefits was a decline in volatility (MARKET:VIX) in equity markets. Through Feb. 28, according to a Morgan Stanley analysis, Fed purchases hav totaled about $456 billion.
The rise in bond yields after the program was initiated was a sign of increased optimism about growth and the feeling among bond traders that more purchases would not be needed.
“All these developments are what one would expect to see when monetary policy becomes more accommodative, whether through conventional or less conventional means,” Bernanke said.
The Fed chairman’s outlook for the economy was not different from recent comments: Bernanke stands cautiously optimistic that the recovery will be sustainable and that growth would pickup in 2011. The housing market, however, is “exceptionally weak,” he said.
“Until we see a sustained period of stronger job creation, we cannot consider the recovery to be truly established,” he added ahead of a key report on payrolls growth that is due on Friday.
“We do see some grounds for optimism about the job market over the next few quarters,” Bernanke noted.
He cited the sharp drop in the U.S. unemployment rate over the past two months, to 9% for February, as well as fewer claims for state unemployment insurance filed in recent weeks.
But the projected jobs growth may nonetheless keep the unemployment rate above normal, he said. The U.S. jobless rate has been at or above 9% for 20 consecutive months.
Most of the questions from the Senators focused on the tense standoff in Congress on the federal budget.
Such a temporary proposal would avoid, for now at least, a government shutdown, while negotiations play out on crafting a budget for the remainder of the year of the federal government’s fiscal year.
Questioned about the economic fallout, Bernanke said the House Republican plan would lower economic growth but would not slam the economy as some have predicted.
Democrats have cited studies by Moody’s Analytics predicting 700,000 lost jobs and Goldman Sachs forecsting a big reduction in gross domestic product.
In contrast, Bernanke said a Fed staff analysis concluded that GDP growth rate would be cut “by a tenth or two” this year and then have an additional impact in 2012.
The Fed chairman has repeatedly told Congress to pay more attention to a long-run sustainable growth plan. He noted that $60 billion in budget reductions would not have much impact on the deficit outlook.