Fed's Bernanke: Stable Inflation Expectations Mute Price Swings
Swings in volatile energy and food prices will have minimal impact on inflation as long as expectations about inflation are held steady, Federal Reserve Chairman Ben Bernanke said on Tuesday.
"If inflation expectations are well anchored, changes in energy (and food) prices should have relatively little influence on 'core' inflation, that is, inflation excluding the prices of food and energy," Bernanke said in the text of a speech prepared for delivery to the National Bureau of Economic Research in Cambridge, Mass.
Some analysts have suggested that policy makers may need to pay more attention to broad measures of inflation that include food and energy, given recent persistence of gains in these prices.
However, Bernanke appeared to firmly endorse the Fed's long-standing practice of focusing more heavily on core price measures in setting monetary policy.
"Inflation is less responsive than it used to be to changes in oil prices and other supply shocks," he said.
At the same time, Bernanke said the Fed, when forecasting inflation, must acknowledge any possible effects of jumps in food and energy costs on other price rises.
"Forecasts of core inflation must take into account the extent to which food and energy costs are passed through to other prices," he said.
Jason Schenker, economist at Wachovia in Charlotte, N.C., interpreted Bernanke's comments as indicating that the Fed will be on hold for the rest of the year.
"He (Bernanke) is not discussing the current outlook. He is more discussing how inflation plays in and discussing the importance of containing inflation for long-run growth and stability. This is something we've known for a while. If companies in an economy cannot plan for what future costs will be, it is very difficult for them to have stable employment outlooks," Schenker said.
"We think that at this point it doesn't change the Fed's outlook and we think the Fed is on hold for the rest of the year," he added.
Other analysts interpreted Bernanke's approach as very cautious with regard to impacting the markets.
"It seems like he basically tried hard to side-step any direct market-moving statements. Just the headlines that came out seem nothing really surprising," said Adam Brown, co-head of U.S. Treasury trading at Barclays Capital.
Expectations Are The Key
Bernanke, who presents the Fed's semiannual report on monetary policy to Congress next week, said the extent to which inflation expectations are held steady has "first-order implications" for what happens to inflation and the economy.
One of the reasons inflation is now more stable than in the past in the face of swings in demand is that inflation expectations are now better anchored, he said.
"A one-off change in energy prices can translate into persistent inflation only if it leads to higher expected inflation and a consequent 'wage-price spiral,'" he said.
When the Fed forecasts inflation, it distinguishes between the outlook for the next three to six months and the time horizon beyond that, Bernanke said.
"For all the advances that have been made in modeling and statistical analysis, practical forecasting continues to involve art as well as science," he said.
At its last meeting on June 27-28, the Fed decided to hold the benchmark federal funds rate steady at 5.25%, the level it reached more than a year ago.
In announcing their decision, policy-makers said that while readings on core inflation had improved modestly in recent months, they were waiting for further evidence that price pressures have subsided for good.
As it has for several months, the Fed once again pointed to a tight labor market as a potential source of upward pressure on prices.
Bernanke said in a follow-up question-and-answer session after his speec that he is hopeful to move forward in the "reasonably near future" with ideas on improving communications policies as the central bank.
"We are moving in a very collegial and intellectual way in coming up with new proposals," Bernanke said.
The Fed chief also said interest paid on reserves might serve as an additional instrument of monetary policy control.