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Bernanke’s Inflation Comments Resonate

In my interview with Sen. Jeff Merkley, I asked about the amazing comment from Federal Reserve Chair Ben Bernanke about inflation and job growth. It’s probably the most explosive technocrat-speak paragraph in recent memory, and I wanted to actually put it here in full. The question came from economist Brad DeLong:

Q: Why haven’t you adopted a 3% per year inflation target?

A: The public’s understanding of the Federal Reserve’s commitment to price stability helps to anchor inflation expectations and enhances the effectiveness of monetary policy, thereby contributing to stability in both prices and economic activity. Indeed, the longer-run inflation expectations of households and businesses have remained very stable over recent years. The Federal Reserve has not followed the suggestion of some that it pursue a monetary policy strategy aimed at pushing up longer-run inflation expectations. In theory, such an approach could reduce real interest rates and so stimulate spending and output. However, that theoretical argument ignores the risk that such a policy could cause the public to lose confidence in the central bank’s willingness to resist further upward shifts in inflation, and so undermine the effectiveness of monetary policy going forward. The anchoring of inflation expectations is a hard-won success that has been achieved over the course of three decades, and this stability cannot be taken for granted. Therefore, the Federal Reserve’s policy actions as well as its communications have been aimed at keeping inflation expectations firmly anchored.

So let’s boil that down. The Federal Reserve has two main roles – price stability and maximizing employment. This isn’t abstract: the Humphrey-Hawkins Act of 1978 requires the Fed to maintain full employment. So when asked why he isn’t engaging in actions that would move the country toward full employment, Bernanke acknowledges that a higher inflation target would stimulate “spending and output,” which leads to economic growth. But he then says that he cannot do so, because of the threat that setting a higher inflation target might lead to higher inflation than that down the road. In other words, the threat of inflation is more crucial than the reality of double-digit unemployment.

This just sums up the anger over Bernanke on the left – he is acting in contravention of the Administration’s stated goal to reduce unemployment. And as Matt Yglesias says, Bernanke doesn’t offer an alternative vision to maximize employment. He’s just giving up on it, on a problem as central to the Fed’s core mission as price stability.

Even Bernanke’s old pal Paul Krugman hammered him on this today:

Future economic historians will, I believe, see this as fundamentally absurd — as absurd as the inflation fears that paralyzed the Bank of England in the early 1930s even as the world went into a deflationary spiral. Yes, there may someday be a 1970s-type episode in which the Fed needs to fight inflation, not encourage it — but it’s a long way off. Furthermore, why on earth would we imagine that the Bernanke Fed, by showing itself willing to inflict gratuitous pain in 2010, would make it easier for whoever is running the Fed in, say, 2020 to control inflation then, let alone that the tradeoff of real pain now versus hypothetical pain much later, if it even exists, is worth making?

Anyway, as far as I can see nobody is even trying to assess these alleged tradeoffs seriously. Instead, the notion of an unchanging inflation target — not to be revised even in the face of the worst slump since the Depression — has acquired a sort of mystical force; it has become identified with the notion of Civilization, in much the way that a previous generation assigned mystic significance to the gold standard.

This is appalling on so many levels, the biggest being that Bernanke is content to leave a generation behind – near-term joblessness hurts the young’s earning capacity over time – to keep faith with the banks. And only Jeff Merkley, on the Democratic side, has a problem with this?

I don’t agree with a word Larry Kudlow says here (his data is completely wrong, for one), but I hope he’s right about one thing:

I wonder if he realizes just how much opposition he may have. Unless he thinks he can garner a truly bipartisan vote in the weeks ahead, I wonder if he should consider withdrawing his name.

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David Dayen

David Dayen