September 21, 2010 / 11:08 PM / 9 years ago

Bernanke's emphasis on inflation may lure hawks

WASHINGTON (Reuters) - Federal Reserve Chairman Ben Bernanke has ratcheted up the central bank’s focus on the threat of deflation, an attempt to win over inflation hawks ruffled by the prospect of fresh monetary easing.

Three times in its brief post-meeting statement on Tuesday, the Fed’s policy-setting committee framed its forecasts and policy stance in terms of returning the path of inflation to levels “consistent with its mandate.”

It was a small but substantive modification that, along with a grimmer take on the economy that hinted at lower growth projections, appeared to clear the way for a new phase of bond buying, or quantitative easing.

“It looks to us like the chairman is preparing to take on the hawks,” said Ian Shepherdson, chief U.S. economist at High Frequency Economics. “This is a big change, and we are inclined to interpret this shift as setting the groundwork for QE part 2.”

Shepherdson and many others economists now see the Fed relaunching bond purchases as early as November, expanding on the $1.7 trillion the central bank has already bought.

Bernanke, who is speaking at Princeton University on Friday, was still smarting from a media leak following the Fed’s August meeting that cast the central bank as deeply split.

The report in the Wall Street Journal caught the central bank’s Washington power center flat-footed as it quickly lost control of the policy message.

The talk of divisions was borne out in subsequent public remarks by Fed officials, who offered differing interpretations for the central bank’s August decision to begin using funds from maturing mortgage bonds held in its portfolio to buy more longer-term government debt.

Attuned to the concerns of his more hawkish colleagues, who worry that further asset purchases might not be effective and could fuel financial imbalances, Bernanke has swiftly adapted by framing the argument in terms they may find hard to ignore.

At heart, most hawks see the inflation side of the Fed’s dual mandate as leading the employment end. According to this view, the best way to foster a vibrant economy is to ensure that prices rise at a modest and steady clip.


By tying future action to the direction of prices, which the Fed statement acknowledged were “below those the committee judges most consistent, over the longer run, with its mandate,” Bernanke accomplished two things.

First, he left himself enough wiggle room to take decisive action if the data appear to warrant it.

At the same time, he offered a clearer benchmark for further easing that is more amenable to hawks on the Federal Open Market Committee, represented most loudly by Kansas City Federal Reserve Bank President Thomas Hoenig.

“It’s now all about inflation, or the potential lack thereof,” said Michael Gregory, senior economist at BMO Capital Markets. “Despite hints of division among Fed policymakers in the recent FOMC minutes and in recent media reports, falling inflation seems to be a rallying cry for common ground.”

Which inflation measures the Fed chooses to focus on could make a big difference. The Fed’s comfort range for the core personal consumption expenditures price index is between 1.7 percent and 2 percent. In July, it stood at 1.4 percent.

But another important core price gauge, the consumer price index excluding food and energy, has held just shy of 1 percent for several months running, a worrisome trend for some policymakers. Of particular concern is the prospect that subdued price growth could turn into outright deflation, an awkward adversary for central banks.

In maintaining a fairly negative view of the economy, the Fed appeared to be preparing to downgrade its growth forecasts and, possibly, to unleash further unconventional action.

In July, the Fed said it saw gross domestic product expanding between 3.5 percent and 4.2 percent in 2011, a level many economists now see as unrealistic. In the second quarter of this year, U.S. GDP grew just 1.6 percent.

“It’s really hard to get from where you are now to that growth path without them doing something,” said John Canally, chief economist at LPL Financial in Boston.

Additional reporting by Emily Kaiser; Editing by Diane Craft

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