Financial Times Editorial Comment: Bernanke explains the Fed to the world
Financial Times Editorial Comment: Bernanke explains the Fed to the world
Copyright by The Financial Times
Published: March 30 2007 00:09 | Last updated: March 30 2007 00:09
Copyright The Financial Times Limited 2007
“It depends” is not the most useful of answers, especially when the question is the future level of US interest rates. The Federal Reserve did itself no favours with a confusing monetary policy statement last week. But this week’s testimony to Congress by Ben Bernanke, the Fed’s chairman, shows that the central bank’s policy has changed little, and still makes sense.
In its statement last week the Fed said that inflation remains its biggest concern but did not mention any further tightening of monetary policy. The markets took that to mean that the Fed is getting closer to cutting interest rates. But in his testimony to Congress Mr Bernanke argued that inflation is more likely to remain too high than fall too far, implying that rates will stay on hold at 5.25 per cent, their current level, for some time yet.
The Fed is at fault for confusing the market, though its mistake was to try and calibrate its message too precisely, rather than a more fundamental error. Its Open Market Committee wanted to acknowledge mixed economic news and show that the balance of risks to its forecast have changed. But the English language is not precise enough to convey that in a sentence or two: Mr Bernanke’s testimony – several thousand words long – did a better job.
The Fed’s view is now fairly clear. It thinks that the economy will continue to grow and core inflation, which at 2.7 per cent is still higher than makes the central bank comfortable, will ease slowly. It does not expect weakness in the housing market to cause a sharp economic slowdown.
The futures market, which is pricing in a rate cut by the end of the summer, is less optimistic. The factors that will decide the issue are housing, business investment and the labour market.
US house prices are stagnant, new construction is down, fewer houses are being bought and sold, and there has been a rise in defaults on so-called subprime mortgages. The housing slowdown will mean weaker growth in consumer spending, but unless the value of existing homes starts to fall, the troubles in subprime are unlikely to mean mass mortgage defaults and serious harm to the economy.
Business investment, which Mr Bernanke flagged as a risk, has been weak since the end of last year. With credit spreads low and the economy still growing, that is both a surprise and a problem: one that will worry the Fed if it continues.
But the issue that will trump all others is the labour market. Unemployment, at 4.5 per cent, is still low and that lack of spare capacity could put pressure on wages and therefore inflation. Unless the Fed expects unemployment to rise, which would leave unused capacity in the economy and create an output gap, then it has little reason to cut rates, but if there is any weakness in the labour market then rate cuts should quickly follow. That, at least, is quite straightforward.
Copyright by The Financial Times
Published: March 30 2007 00:09 | Last updated: March 30 2007 00:09
Copyright The Financial Times Limited 2007
“It depends” is not the most useful of answers, especially when the question is the future level of US interest rates. The Federal Reserve did itself no favours with a confusing monetary policy statement last week. But this week’s testimony to Congress by Ben Bernanke, the Fed’s chairman, shows that the central bank’s policy has changed little, and still makes sense.
In its statement last week the Fed said that inflation remains its biggest concern but did not mention any further tightening of monetary policy. The markets took that to mean that the Fed is getting closer to cutting interest rates. But in his testimony to Congress Mr Bernanke argued that inflation is more likely to remain too high than fall too far, implying that rates will stay on hold at 5.25 per cent, their current level, for some time yet.
The Fed is at fault for confusing the market, though its mistake was to try and calibrate its message too precisely, rather than a more fundamental error. Its Open Market Committee wanted to acknowledge mixed economic news and show that the balance of risks to its forecast have changed. But the English language is not precise enough to convey that in a sentence or two: Mr Bernanke’s testimony – several thousand words long – did a better job.
The Fed’s view is now fairly clear. It thinks that the economy will continue to grow and core inflation, which at 2.7 per cent is still higher than makes the central bank comfortable, will ease slowly. It does not expect weakness in the housing market to cause a sharp economic slowdown.
The futures market, which is pricing in a rate cut by the end of the summer, is less optimistic. The factors that will decide the issue are housing, business investment and the labour market.
US house prices are stagnant, new construction is down, fewer houses are being bought and sold, and there has been a rise in defaults on so-called subprime mortgages. The housing slowdown will mean weaker growth in consumer spending, but unless the value of existing homes starts to fall, the troubles in subprime are unlikely to mean mass mortgage defaults and serious harm to the economy.
Business investment, which Mr Bernanke flagged as a risk, has been weak since the end of last year. With credit spreads low and the economy still growing, that is both a surprise and a problem: one that will worry the Fed if it continues.
But the issue that will trump all others is the labour market. Unemployment, at 4.5 per cent, is still low and that lack of spare capacity could put pressure on wages and therefore inflation. Unless the Fed expects unemployment to rise, which would leave unused capacity in the economy and create an output gap, then it has little reason to cut rates, but if there is any weakness in the labour market then rate cuts should quickly follow. That, at least, is quite straightforward.
posted by Carlos T Mock @ 9:07 AM
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