Wednesday, Ben Bernanke will discuss with reporters decisions taken by the Federal Reserve Open Market Committee. For this unprecedented press conference to be successful, Mr. Bernanke must venture where Fed Chairmen are most reluctant to go—into politics.
Economists have long held that transparency about goals and means makes monetary policy more effective. However, genuine transparency requires that Mr. Bernanke acknowledge the limits imposed on the Fed policy by the actions of Congress, the Administration, and foreign governments.
Inflation is heating up, thanks to rising oil, food and other commodity prices. Many in Congress and financial markets blame QE2—the Fed’s policy of purchasing Treasury securities to moderate interest rates on mortgages, corporate bonds and the like—but easy money is not causing inflation.
China and several other Asian governments choose to keep their currencies substantially undervalued against the dollar and regulate domestic gasoline and other commodity prices. Those policies boost Asian exports and growth, slow U.S. and European growth, and push up global prices for oil and other commodities.
Growth in developing countries is inordinately energy and other-commodity intensive, as greater prosperity translates into more cars, apartments and commercial buildings, roads, and richer diets—more meat and milk that require grains to produce. All that pushes up global prices for the oil, building materials and food those economies must import in massive quantities to grow quickly.
Moreover, those governments must print and trade huge amounts of their currencies for dollars with U.S. and EU importers to keep their currencies from rising in value against the dollar in foreign exchange markets. That gives those governments piles of greenbacks to subsidize oil imports, keep domestic prices for gas and diesel from rising too quickly, and shift the burden of tighter global oil supplies onto the United States, Europe, and poorer developing countries.
In the United States, the immediate result is soaring gas and food prices, even as unemployment remains uncomfortably high and wages hardly keep pace with inflation.
The Fed can do little about the actions of foreign governments to control that inflation, but the United States is not helpless. Economists on the right, the left and in the center have articulated policies the Treasury could pursue, in addition to G20 diplomacy, to neutralize Beijing’s and other government’s currency manipulation. President Obama has acknowledged the potential effectiveness of those options but nixed their use.
Ben Bernanke has articulated the connection between Beijing’s exchange rate policy and slower U.S. growth, and he well understands the direct connection between China’s currency policies and protectionism, on the one hand, and U.S. oil and food inflation, on the other.
Mr. Bernanke would do his cause, and the nation’s understanding of the choices he faces, a lot of good if he would articulate the connection between China’s currency manipulation and rising gas and food prices, the limits of Fed power to manage inflation, and the options available to the Treasury to accomplish solutions. However, Mr. Bernanke won’t embarrass a Treasury Secretary and President too timid to act, and will continue to carry the pail for the Administration’s inaction.
Year-over-year, energy prices are up 16 percent—gasoline, 28 percent—and food prices have increased 3 percent, while inflation on other items is barely more than one percent. Considering the latter include health care and college tuition, where government policies drive prices ever higher, inflation in the free-market private sector is no more than one percent a year.
Easy monetary policy causes inflation when the economy is near full employment—then too much money chases too few goods. But with 8.8 percent unemployment, wages are hardly moving, and productivity growth has permitted firms to absorb much of the cost of higher energy and other commodity prices.
Simply, low interest rates and QE2 are not driving inflation. If members of Congress, like Representative Ron Paul, want inflation fixed, they should address currency and trade problems with China. However, they are reluctant to seize exchange rate policy from the Treasury and President. Instead, they score points and troll for votes by trashing the Fed, and will continue to do so, until Mr. Bernanke pushes back.
This is the core of Mr. Bernanke’s challenge on Wednesday. The Fed is supposed to be non-political; but if he is to explain monetary policy to the public—its purposes and limits—and create the transparency economists believe improves Fed effectiveness, he must be political.
On the blackboards of graduate seminars, economics is physics—energy, actions and reactions— but in Washington it’s nothing more or less than raw politics.
Peter Morici is a professor at the Smith School of Business, University of Maryland, and former Chief Economist at the U.S. International Trade Commission.