Monday, June 16, 2008

Bernanke not to blame for America's economic woes

Business Times - 17 Jun 2008


AT first, the US Federal Reserve chairman was criticised for his slow response to the housing crisis and credit crunch, with critics arguing that he should have started cutting interest earlier on and more frequently.

In this narrative, in which Americans are losing their homes, going bankrupt and are in fear of losing their jobs, the boss of the US central bank emerged as the villain who is partly responsible for the ensuing economic downturn aka 'recession'. But now, Mr Bernanke is being criticised for the fact that he has been cutting interest rates too often and by too much. In this other narrative, dominated by rising energy and commodity prices, the Fed chairman is the villain who should be held accountable in one way or another for what looks to some observers as inflation.

While economists continue to debate whether we are now in a recession or are under the threat of inflation, or whether that old arch enemy called 'stagflation' is rearing its ugly head, the fact is, for the average American who is not familiar with the intricacies of the dismal science, it really doesn't matter whether it's a recession or inflation or a stagflation, or all of the above.

The average American worries about the prospect of paying US$6 for a gallon of petrol by the end of the summer and using up his credit card and losing his home and his job, or some combination of these depressing scenarios. Notwithstanding the rebate cheque that he or she will be receiving from the US Treasury Department this month - thanks to the economic stimulus plan - the economy seems to be in a mess and someone should be held responsible for that.

Hence, the tendency to scapegoat the Fed, which is understandable since only a few years ago, the same Fed, led by another chairman, was being lionised for its success in producing what some expected to become a never-ending and inflation-free economic boom.

If anything, one could make the argument that the monetary policies pursued by the former Fed chairman helped induce the current housing and financial crises, and that Mr Bernanke had no choice but to cut interest rates forcefully as part of the strategy aimed at pre-empting a catastrophic financial meltdown.

It's true that this aggressive monetary policy ended up putting downward pressure on the US dollar (whose value has fallen as a result of large trade and budget deficits), and that that, in turn, helped expand US exports - which is certainly very good news if your goal is to get the American economy out of a recession.

But the same monetary policy and weak US dollar has also put upward pressure on energy prices - which explains why these are rising and fuelling inflation. But the main driving force behind the increase in the prices of energy and other commodities has more to do with market forces - more demand and less supply and sellers demanding more US dollars as a hedge against its declining exchange value - and less to do with what the US central bank should or should not have done.

Still, some critics have suggested that, by providing more liquidity, the Fed also ended up injecting more resources for financial institutions to speculate in oil futures - which may have ignited an oil futures bubble and put even more upward pressure on energy prices.

In any case, the Fed recognises that even if the inflation threat is still dormant, both consumers and investors are expecting prices to rise. According to the Conference Board, American consumers expect prices to go up by 7.7 per cent in 2009 while investors project an annual inflation rate of 3.4 per cent over the next 10 years, which creates the conditions for a self-fulfilling inflationary cycle, leading to wage and price spiral, as workers demand wage increases in response to the rise in the prices of commodities.

Hence, the concern expressed by Mr Bernanke last week that the latest round of increases in energy prices 'has added to the upside risks to inflation and expectations' and may have created an environment that could 'lead the public to expect higher long-term inflation rates, an expectation that ultimately could become self-confirming'. Mr Bernanke stressed that the central bank would 'strongly resist' this trend.

These and similar comments by Mr Bernanke and other Fed officials, including expressions of concern about the falling value of the US dollar, suggest that the Fed now seems less concerned about the recession that may or may not have come - the news that unemployment rose to 5.5 per cent in May from 5 per cent in April was certainly not encouraging - and more about the public expectation of inflation. It remains to be seen if the Fed will start increasing interest rates anytime soon.

But whatever Mr Bernanke does next, it is certainly not going to change the depressed American mood on the economy.

Copyright © 2007 Singapore Press Holdings Ltd. All rights reserved.

1 comment:

daveg said...

Depends on which woes you are talking about, no?

Obviously, the housing bubble is (largely) Greenspan's legacy.

However, inflation is clearly Bernanke's. He has chosen inflation over economic pain.

Economic woes due to high oil prices (about 50% inflation related) are Bernanke's fault.

Only time will tell if that was the right decision. I would personally rather have seen a little tighter money and a little more recession, as that focuses the mind and forces companies to shed bad practices.