Investors recently have gotten clear signals of what life will be like under Ben Bernanke, and they don’t seem to be smitten.
After the new Federal Reserve chairman gave a speech warning of the threat of renewed inflation, financial markets experienced their worst week of the year. The worry is that he is too inclined to increase interest rates, which could dampen economic growth and erode profits.
Bernanke obviously has yet to instill the confidence inspired by his predecessor, Alan Greenspan, so markets tend to overreact to his statements. It may be hard to remember now that Bernanke initially was suspected of being an inflation dove. If he is going to err, he’s better off erring on the side of being overly vigilant about prices.
After the successes of the last 25 years, it’s easy to assume that inflation is a mild creature that can be confined to its cage easily, but it took enormous resolve on the part of the Fed to tame the monster that ravaged the economy in the 1970s and early 1980s. Bernanke has been around long enough to understand that the dangers of excessive vigilance in the short run are modest compared to the long-run dangers of laxity.
At this stage, the warning signs are numerous enough to justify putting a priority on combating inflation. He has indicated that he thinks the Fed should strive to keep the inflation rate between 1 percent and 2 percent annually. By that measure, it has been fighting a losing battle.
Last year, the Consumer Price Index climbed by 3.7 percent, the result partly of high oil prices. Core prices, which exclude the notoriously volatile food and oil items, have been increasing at a 3 percent rate so far this year, and the president’s Council of Economic Advisers projected that the overall CPI increase will amount to 3 percent this year.
The price of gold, generally a good barometer of inflation expectations, is up by nearly 13 percent from a year ago. Surveys indicate that consumers think higher inflation lies ahead.
Such attitudes encourage companies to try to increase prices, complicating the Fed’s perpetual task of promoting healthy growth while restraining inflation. So Bernanke has good reason for signaling that, absent a conspicuous softening in the economy, the Fed is leaning toward another increase in the federal funds rate when it meets next later this month.
Like any form of excess, overly loose monetary policy is easy to indulge and unpleasant to give up. As Chicago economist Brian Wesbury recently put it, weaning investors, builders and other interested parties off of “50-year low interest rates is like forcing them to quit smoking: It’s good for the economy, but it hurts and they are complaining loudly.”
The alternative of partying our way into poor economic health is no alternative at all. A tighter Fed may feel a bit constricting right now, but in time, it will help us all breathe easier.
