Former Federal Reserve Board Chairman Ben Bernanke speaks during a discussion on “Monetary Policy Prospects” during the Thomas Laubach Research Conference at the Federal Reserve Board building in Washington, DC May 19, 2023.
Saul Loeb | AFP | Getty Images
WASHINGTON – Former Federal Reserve Chairman Ben Bernanke, who guided the central bank and the US economy through the Great Recession, believes central bankers still have work to do to bring inflation down.
That work, he and economist Olivier Blanchard argue in a paper published on Tuesday, will bring about a slowdown in what has been a phenomenally resilient job market.
The duo offer no specific guidance on how much unemployment needs to rise, but suggest the current Fed can find a way out of this predicament without seriously hurting the US economy.
“Looking ahead, we conclude that labor market slack is still below sustainable levels and inflation expectations are slightly higher. Therefore, we conclude that the Fed is unlikely to avoid a slowdown in the economy to return inflation to target levels,” write Bernanke and Blanchard in the paper.
Since leaving the Fed in 2014, Bernanke has been a distinguished senior fellow at the Brookings Institution. Blanchard is a Senior Fellow at the Peterson Institute for International Economics.
Their paper said inflation has been evolving since it hit a 40-year high in the summer of 2022. First, prices skyrocketed as consumers took advantage of Congressional and Federal Reserve stimulus to shift spending from services to goods, causing supply shortages and fueling inflation.
However, they note that the new phase is now being driven by an increase in wages trying to catch up with price increases. The good news is that such shocks are generally manageable, but they said the Fed must continue trying to manage the labor market situation, where the unemployment rate is at 3.4% and there is still about 1.6 remaining jobs for every available worker.
“The part of inflation that originates from overheating labor markets can only be reversed through policies that better balance labor demand and supply,” say Bernanke and Blanchard.
A look ahead and back
But the paper looks at both what caused the surge that took headline inflation, as measured by the CPI, to over 9% last year and what happens from now on.
Most economists agree that a combination of trillions in government spending combined with zero interest rates and nearly $5 trillion in Fed bond purchases flooded the economy with money and created distortions that caused prices to rise.
In a forum hosted by the Brookings Institution on Tuesday, Bernanke, Blanchard and other top economists and scientists discussed the causes and what policymakers should do when reviewing policies for the future.
Considerations included supply and demand factors, how much Covid itself was influencing consumer decisions, and whether a new policy framework that the Fed passed in September 2020 that sought not only full employment but also “broad-based and inclusive” played a role role in economic dynamics.
“The quantitatively greater sin was fiscal policy, particularly for 2021. However, the less forgivable sin was monetary policy,” said Jason Furman, former chair of the Council of Economic Advisers and now a Harvard economics professor.
“I have lower expectations of fiscal policy. If they send the right signals, I’ll be pleasantly surprised,” he added. “Monetary policy has made the mistake again and again, in one meeting after another. … I actually have higher expectations of the Fed than just making the right mark.”
As inflation surged past the Fed’s 2% target, policymakers continued to describe the trend as “temporary” and barely began discussing when it would scale back its asset purchases. The Fed only started raising interest rates in March 2022, a full year after its favorite inflation indicator eclipsed the target.
Since then, policymakers have hiked interest rates ten times by a total of five percentage points, bringing the interest rate to its highest level in almost 16 years.
“A mistake in tactics”
Former Fed Vice Chairman Richard Clarida, who sat on the Federal Open Market Committee during the inflation surge, said the policy missteps were not due to over-compliance with the policy framework adopted in 2020, which came amid racial unrest in the US took place across the country. He called the Fed’s reluctance to tighten monetary policy “a mistake in tactics, not strategy” and attributed it to the “fog of war”.
He also noted that the Fed is not alone: Many other global central banks have chosen not to raise interest rates in the face of rising inflation.
“No central bank in advanced economies began raising interest rates until inflation exceeded target,” Clarida said. “Why this happened is obviously a very important and interesting question that says more about the practice of inflation-oriented central banks in this area than any particular implementation of a framework.”
The Bernanke-Blanchard paper points to the danger of central banks holding inflation for too long and the impact this has on price expectations.
“The longer the period of overheating lasts, the stronger the catch-up effect and the weaker the anchoring of expectations, the larger the effect of labor market tightening on inflation and also, implicitly, the stronger the eventual monetary contraction required to reverse inflation “Target, all else being equal,” they wrote.