Bernanke explains Fed stance on inflation
Sunday, 15 July 2007
Krishna Guha
BEN Bernanke offered a subtle explanation of the way the Federal Reserve views core and headline inflation in a recent speech to the National Bureau of Economic Research.
The Fed chairman's remarks came amid debate in the market over what some see as a shift by the Fed to put less emphasis on the current rate of core inflation, which excludes volatile food and energy prices.
Bernanke made it clear the Fed had not abandoned its belief that current core inflation was a better guide to future inflation than current headline inflation.
"With inflation expectations well anchored, a one-time increase in energy prices should not lead to a permanent increase in inflation, but only to a change in relative prices," he said.
But he also made it clear that Fed policy was forward-looking and based on its forecast of overall inflation in the future, not the current rate of core inflation.
The inflation forecast was in turn made up of a forecast for the future rate of core inflation, plus a separate estimate of future food and energy price increases based largely on futures prices, he added.
The current rate of core inflation is an input into the forecast, but Mr Bernanke explained that other factors went into the mix as well, potentially including the pressure of demand on supply, various measures of inflation expectations and labour market conditions.
The implication is that the Fed will not respond mechanically to changes in the current core rate.
In general, Mr Bernanke said, more firmly anchored inflation expectations meant that "inflation will now tend to be more stable than in the past in the face of variations in aggregate demand".
This, he said, "can be a good thing or a bad thing, depending on whether inflation expectations are anchored in the vicinity of price stability".
In a speech earlier this year Fed governor Rick Mishkin argued that inflation expectations appeared to be stable at levels compatible with a trend inflation rate of about 2.0 per cent.
The Mishkin analysis implies that it would be costly to try to drive inflation much below that rate, absent a change in the policy framework that itself changed these expectations.
Bernanke's speech did not contradict that view, but he argued against assuming that inflation expectations were completely frozen.
The Fed chairman observed "long-run inflation expectations do vary over time . . . they are not perfectly anchored".
He also noted that "the extend to which they are anchored can change, depending on economic developments and (most important) the current and past conduct of monetary policy".
Bernanke said the Fed might be able to affect inflation expectations directly through the way it set interest rates.
To the extent that it was able to do so, "the output costs of disinflation may be lower" than analysis based only on the balance of supply and demand in the economy would suggest.
Under syndication arrangement with FE
BEN Bernanke offered a subtle explanation of the way the Federal Reserve views core and headline inflation in a recent speech to the National Bureau of Economic Research.
The Fed chairman's remarks came amid debate in the market over what some see as a shift by the Fed to put less emphasis on the current rate of core inflation, which excludes volatile food and energy prices.
Bernanke made it clear the Fed had not abandoned its belief that current core inflation was a better guide to future inflation than current headline inflation.
"With inflation expectations well anchored, a one-time increase in energy prices should not lead to a permanent increase in inflation, but only to a change in relative prices," he said.
But he also made it clear that Fed policy was forward-looking and based on its forecast of overall inflation in the future, not the current rate of core inflation.
The inflation forecast was in turn made up of a forecast for the future rate of core inflation, plus a separate estimate of future food and energy price increases based largely on futures prices, he added.
The current rate of core inflation is an input into the forecast, but Mr Bernanke explained that other factors went into the mix as well, potentially including the pressure of demand on supply, various measures of inflation expectations and labour market conditions.
The implication is that the Fed will not respond mechanically to changes in the current core rate.
In general, Mr Bernanke said, more firmly anchored inflation expectations meant that "inflation will now tend to be more stable than in the past in the face of variations in aggregate demand".
This, he said, "can be a good thing or a bad thing, depending on whether inflation expectations are anchored in the vicinity of price stability".
In a speech earlier this year Fed governor Rick Mishkin argued that inflation expectations appeared to be stable at levels compatible with a trend inflation rate of about 2.0 per cent.
The Mishkin analysis implies that it would be costly to try to drive inflation much below that rate, absent a change in the policy framework that itself changed these expectations.
Bernanke's speech did not contradict that view, but he argued against assuming that inflation expectations were completely frozen.
The Fed chairman observed "long-run inflation expectations do vary over time . . . they are not perfectly anchored".
He also noted that "the extend to which they are anchored can change, depending on economic developments and (most important) the current and past conduct of monetary policy".
Bernanke said the Fed might be able to affect inflation expectations directly through the way it set interest rates.
To the extent that it was able to do so, "the output costs of disinflation may be lower" than analysis based only on the balance of supply and demand in the economy would suggest.
Under syndication arrangement with FE