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Bernanke's Darkest Fears
Jessica Holzer,
WASHINGTON, D.C. - In a hawkish speech on Monday that may have sealed his reputation as a blunt talker, U.S. Federal Reserve Chairman Ben Bernanke aired his worries about accelerating inflation and suggested strongly that the Fed is not yet done with its rate tightening. The Fed chief told a crowd of solemn, dark-suited bankers assembled for the International Monetary Conference at the Willard Hotel in Washington that core inflation had crept to levels beyond the comfort zone of many economists, including Bernanke. Then he laid out exactly what the worrisome levels were, saying that quarter inflation had been running at 3% over the past six months and 2.3% over the past 12 months. Previously, Bernanke had said that core inflation should run between 1% and 2% a year. "These are unwelcome developments," he said flatly. The tough talk surprised the markets, which had been expecting a pause in the Fed's rate-raising at its next meeting on June 29 amid growing signs that the economy is losing momentum. The Fed has raised rates 16 times in a row, to 5%, since June 2004. Both stock and bond prices fell, with the Dow Jones industrial average and the Standard & Poor's 500 indexes dropping about 1.75% and the Nasdaq National Market Index slumping more than 2% in the steepest one-day fall since January. Meanwhile, market expectations of another rate hike in June, as gauged by the purchases of federal funds futures, shot up as high as 76%, from 50%, where it had sunk on the heels of a weak job report on Friday. Bernanke's direct approach was in sharp contrast to his predecessor, the enigmatic Alan Greenspan, who avoided giving specific numbers at all costs, lest he be boxed in. "That was rather surprising that he has put it on paper--the target range," said John Silvia, the chief economist at Wachovia Securities in Charlotte, N.C. Bernanke's speech was also notable for the lack of hedging statements to water down its tone. While Bernanke acknowledged at the outset that the economy was showing signs of flagging, he did not dwell much on the fact that monetary policy works with a lag and that core inflation tends to rise and fall when the economy slows down, said John Lonski, chief economist at Moody's. "What was disturbing is that he failed to indicate more clearly how a slowing economy could diminish the risk of accelerating inflation that would require further rate hikes," said Lonski. Rising oil and commodities prices present a dilemma for a central bank, because they raise the risk of both an economic slump and spiraling inflation. By hiking rates again in June, which would bring the rate to 5.25%, the Fed would signal its resolve to not repeat the mistakes of the 1970s Fed, which contributed to runaway prices and stagnation with its loose monetary policy. But while tightening interest rates is the right response to signs that rising energy costs are seeping into other prices in the economy, Bernanke's bluntness may come back to bite him if, say, core inflation or the economy start to slow. "He's saying these are unwelcome developments. That's understandable," said Brian Bethune, a U.S. economist at Global Insight, an economic forecasting firm in Lexington, Mass. "A recession is an unwelcome development as well." The World's Best Big Companies
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U.S. Federal Reserve Chairman Ben S. Bernanke has told an International Monetary Conference inflation is creeping higher and will receive "particular scrutiny."

Ben Bernanke: the economist took over from Alan Greenspan as head of the Federal Reserve in January 2006

Benanke's comments, to an audience of bankers at the Willard Hotel in Washington, has tripped up stocks and bonds which fell by 199 points on US markets Monday (1.8 per cent loss).

The comments seem to have been interpreted by traders to mean there will be an interest rate rise.

A strategist at Wells Capital Management said: "Here we have some suspicion the economy may be weakening ... and a struggling stock market," "And the Fed chairman chooses Monday to inform everyone he has decided to get tough on inflation," says Jim Paulsen.

The panicked markets had expected no rate rise at the next Federal Reserve meeting on June 29. The United States central bank began raising interest rates two years ago - 16 consecutive rises later it stands at 5%.  

The news might also suggest the billowing crude and commodity markets have affected other parts of the economy. Excluding energy or food prices, core inflation was "at or above the upper end of the range that many economists, including myself, would consider consistent with price stability," Mr Bernanke said.

Bernanke said his core inflation canal was between 1% and 2% a year. Quarter inflation, however, was rising: 3% through six months; 2.3% over 12 months. "These are unwelcome developments," Bernanke said when he announced the figures.

Overall the economic data was "consistent with the softening in the pace of overall economic activity that seems to be under way," Bernanke said in his speech.
  
Stagflation is the economic problem of rising inflation and falling growth. The Federal Reserve often lower interest rates to finance the economy but in an inflationary economy interest rates might also need to rise. Such a situation might put the Fed in an uncomfortable pinch.  

Monetary policy is an incomplete science. Even so, Bernanke is old enough to remember the 1970s when the Federal Reserve declined an interest rate rise. Recession and high prices appeared to be the result.