Damned If You Speak, Damned If You Don’t

Ben Bernanke’s performance at the Federal Reserve’s historic first-ever press conference succeeded in pleasing no one while further stoking criticism from all sides. Perhaps that was inevitable. There was almost zero chance that one more prepared speech, or even taking questions from the press like a run-of-the-mill politician, would change deeply entrenched views about what the Fed could or couldn’t do. But the former Princeton professor gave it a shot.


Congressman Ron Paul, Fed critic-in-chief, certainly wasn’t impressed. He dismissed the event for most part, charging that Bernanke’s media event was little more than “smooth talking, to make current policy sound reasonable.”
For Paul and other critics, there was only disappointment that the Fed didn’t raise interest rates to fend off what some say is an approaching wave of higher inflation fed by increasing commodity prices. Yet the policy of keeping rates near zero rolls on, as noted in yesterday’s FOMC statement and reiterated in Bernanke’s public chat.
If the lack of tightening frustrated some, others were distressed for what Bernanke didn’t say, or at least didn’t say clearly, in defense of QE2 and monetary stimulus. Economist David Beckworth, for instance, lamented that most of the inflation questions posed by reporters yesterday

were premised on the assumption that inflation is always a bad outcome that must be avoided at all cost. For example, Robin Harding of the FT asked Bernanke what the Fed could do to prevent inflation expectations from increasing. None of the reporters seemed to grasp and Bernanke failed to explain that a period of catch-up inflation–which really is just a symptom of catch-up nominal spending–could do the economy some good without jeopardizinng long-run inflation expectations. All the Fed would need is to set an explicit level target and run with it as I explain here. And make no mistake, the Fed has the power to make a difference. Just look at how successful the original QE program was in the 1930s, a time of far worse economic conditions.

To Marcus Nunes’ ears, Bernanke sounded a bit more hawkish yesterday:

QE2 will end as planned in June. Monetary policy will “passively tighten”. In the Press Conference Bernanke fretted about core inflation going up, about the danger of rising commodity and oil prices and about inflation expectations – up but still anchored. The “hawks” are in control. There was unanimity but Bernanke conceded their points! To him, it´s a pity long term unemployment continues elevated, but the inflation “dangers” take precedence!

But that´s what you get when you obsess with inflation. The hawks have been “crying wolf” for a long time, even while inflation was tanking during most of 2009 – 2010.

Tim Duy agrees:

The most interesting comments came in response to questions about whether the Fed should do more to lower unemployment and if QE2 is effective, shouldn’t the program continue? Here was a more hawkish Bernanke. As I noted earlier, growth forecasts returned to the pre-QE2 range, which should be a red flag. Unemployment remains high, with only moderate job creation. Core-inflation remains low, while the impulse from commodity prices on headline inflation is expected to be temporary. Finally, he claims that QE2 was in fact effective. So why not do more? Because the Fed needs “to pay attention to both sides of the mandate” and the “tradeoffs are less attractive.” Much talk by Bernanke at this point about inflation expectations, and the importance of maintaining those expectations, and not much (none, I think), about the issue (or non-issue) of wage inflation.

As for the market’s outlook on inflation, yesterday’s media circus didn’t alter expectations much. The implied inflation forecast, based on the yield spread between the nominal and inflation-indexed 10-year Treasuries, was 2.58% yesterday, or down slightly from earlier in the month and roughly in line with levels that preceded the financial crisis of late-2008.

The future, of course, is another matter, and one that Professor John Cochrane thinks may be troublesome. “To buy a 30-year Treasury at its current 4.5% yield and get a decent 2% return, you have to bet that inflation will not exceed 2.5% for the next 30 years,” he writes. “You have to bet they will solve the 2025 deficit.” The “they” he’s referring to is the Congress, of course, and the 2025 deficit is the projected red ink thrown off by the ballooning spending for Social Security, Medicare and Medicaid in the years ahead. “Why do we need to fix the 2025 budget today?” Cochrane asks. “Two words: bond market.”
Unfortunately, the short term isn’t easily dismissed on the road to macroeconomic salvation. The Fed lowered its prediction for economic growth yesterday, forecasting GDP growth in the range of 3.1% to 3.3% for all of 2011—down from January’s estimate of 3.4% to 3.9%. Keep in mind, too, that the unemployment rate is still unusually high at 8.8%. Meanwhile, interest rates remain unusually low—virtually nil via the Fed’s target rate. Now here’s the operative question: What do you think the outlook for GDP and unemployment would be if the Fed started hiking interest rates today? Hold that thought and then ask yourself: How would the stock market react?
Whatever constitutes a solution to the mess we’re in, the clock is ticking. Cochrane advises:

We are still a great nation. The challenge is whether we will accept a vaguely rational tax system and a set of entitlements that protect the vulnerable without bankrupting the Treasury. It’s not rocket science.

But we don’t have much time. The bond market won’t wait. The budget and debt problems will be much harder to solve if long-term interest rates spike, the dollar falls further, and inflation breaks out.

Perhaps the real question is deciding if the “solution” will help or hinder growth now. Focusing on 2025 is critical, but so is keeping GDP bubbling. Which one’s more important? Heck, do you think you’re right leg’s more valuable than your left?
Bernanke can hold as many press conferernces as he wants, but the Great Uncertainty still lurks. Finding the path between promoting growth today and advancing fiscal rectitude tomorrow isn’t going to be easy. In fact, it’s going to be damn risky. No one’s really sure what constitutes the right mix of austerity and stimulus. But Cochrane’s certainly right about one thing: “Our only hope is growth.” The details for minting that outcome, however, are still debatable.