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There is still work to be done to control inflation

Former Federal Reserve Board Chairman Ben Bernanke speaks during a discussion on ‘Perspectives on Monetary Policy’ at the Thomas Laubach Research Conference at the Federal Reserve Board Building in Washington, D.C. DC, May 19, 2023.

Saul Loeb | AFP | Getty Images

WASHINGTON — Former Federal Reserve Chairman Ben Bernanke, who guided central banking and the U.S. economy through the Great Recession, thinks central bankers still have work to do to bring inflation down.

That work, he and economist Olivier Blanchard say in an academic paper published Tuesday, will lead to a slowdown in what has been a phenomenally resilient labor market.

The duo don’t lay out specific prescriptions for how much unemployment needs to rise, but they do suggest it’s possible for the current Fed to orchestrate its way out of this predicament without seriously harming the US economy.

“Looking ahead, with a slowdown in the labor market still below sustainable levels and slightly higher inflation expectations, we conclude that the Fed is unlikely to be able to avoid slowing inflation. economy to bring inflation back to its target,” Bernanke and Blanchard wrote in the article.

Since leaving the Fed in 2014, Bernanke has been a distinguished scholar at the Brookings Institution. Blanchard is a senior fellow at the Peterson Institute for International Economics.

Their paper notes that inflation has moved since hitting a 40-year high in the summer of 2022. Initially, prices jumped as consumers used congressional and central bank stimulus to shift spending from services to goods, creating supply bottlenecks and accelerating inflation. .

However, they note that the new phase is now being driven by rising wages trying to catch up with soaring prices. The good news is that these shocks are generally controllable, but they said the Fed must continue to try to address the labor situation in which the unemployment rate is 3.4% and there are still about 1.6 open jobs for each available worker.

“The part of inflation that originates in overheated labor markets can only be reversed through policy actions that better balance labor supply and demand,” Bernanke and Blanchard say.

A look forward and back

The paper, however, is as much about what caused a surge that pushed headline inflation, as measured by the consumer price index, above 9% last year, as what happens from here.

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 led to price spikes.

At a forum presented by the Brookings Institution on Tuesday, Bernanke, Blanchard and other leading economists and academics discussed the root causes and what policymakers should do when considering policies for the future.

Considerations included supply and demand factors, the influence of Covid itself on consumer decisions, and whether a new policy framework adopted by the Fed in September 2020 that not only sought a full-time but also “broad and inclusive” employment played a role. role in economic dynamics.

“The biggest sin quantitatively was fiscal policy, especially for the year 2021. The least forgivable sin, however, was monetary policy,” said Jason Furman, former chairman of the Council of Economic Advisers and now professor of economics. economics at Harvard.

“I have lower expectations for fiscal policy. When they do the right sign, I’m pleasantly surprised,” he added. “Monetary policy has made the mistake again and again and meeting after meeting. … I have higher expectations for the Fed than just giving the right sign.”

As inflation rose above the Fed’s 2% target, policymakers persisted in calling the trend “transitional” and only began discussing when it would scale back its bond purchases. The Fed only started raising interest rates in March 2022, a year after its favorite inflation gauge eclipsed the target.

Since then, policymakers have raised the benchmark interest rate 10 times for a total of 5 percentage points, taking the federal funds rate to its highest level in nearly 16 years.

“A tactical error”

Former Fed Vice Chairman Richard Clarida, who served on the Federal Open Market Committee during the inflationary surge, said the policy missteps weren’t attributable to over-adherence to the policy framework adopted in 2020 , which occurred amid racial unrest across the country. He called the Fed’s reluctance to tighten policy “a mistake in tactics, not strategy” and attributed it to “fog of war.”

He also noted that the Fed was not alone: ​​Many other global central banks chose not to raise rates amid soaring inflation.

“No advanced economy central bank started raising rates until inflation was above its target,” Clarida said. “Why this happened, obviously, is a very important and interesting question that says more about the central bank’s practice of targeting inflation in the sphere than any particular implementation of a framework.”

Bernanke-Blanchard’s article notes the inherent danger of central banks letting inflation last too long and the impact this has on price expectations.

“The longer the episode of overheating, the stronger the catch-up effect and the weaker the anchoring of expectations, the greater the effect of the tightening of the labor market on inflation and, implicitly, the greater the ‘eventual monetary contraction necessary to bring inflation back to target, all other things being equal,’ they wrote.


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