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 Forecasting America's Destiny ... and the World's


Generational Dynamics Web Log for 11-Jul-07
Fed Chairman Ben Bernanke delivers incredibly bizarre speech on inflation

Web Log - July, 2007

Fed Chairman Ben Bernanke delivers incredibly bizarre speech on inflation

While the rest of the financial world is trying to deal with the subprime mortgage meltdown, Bernanke, who replaced Alan Greenspan as Chairman of the Federal Reserve central bank early in 2006, talked as if the only thing in the world that mattered was whether the rate of inflation was 3% or 4%. Talk about fiddling while Rome burns!

Here's what he's worried about: Do the American people have the proper expectation of the inflation rate? He uses the term "anchored" to mean that people's expectations match reality; thus, if inflation goes up a little and people expect it to continue to go up a little, then inflation expectations are "perfectly anchored"; but if inflation goes up a little and people expect it to go up a lot, then expectations are "poorly anchored."

Can you believe this? Let's go on.

Here are extracts from Bernanke's speech on Tuesday:

"Why do we care about the variability of inflation expectations? ... [Because] the extent to which inflation expectations are anchored has first-order implications for the performance of inflation and of the economy more generally.... [A] lower sensitivity of long-run inflation to supply shocks would imply that such shocks are much less likely to generate economic instability today than they would have been several decades ago. Notably, the sharp increases in energy prices over the past few years have not led either to persistent inflation or to a recession, in contrast (for example) to the U.S. experience of the 1970s. ...

Fed Chairman Ben Bernanke on February 28 <font face=Arial size=-2>(Source: CNN)</font>
Fed Chairman Ben Bernanke on February 28 (Source: CNN)

Similar logic explains the finding that inflation is less responsive than it used to be to changes in oil prices and other supply shocks. Certainly, increases in energy prices affect overall inflation in the short run because energy products such as gasoline are part of the consumer's basket and because energy costs loom large in the production of some goods and services. However, 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." With inflation expectations well anchored, a one-time increase in energy prices should not lead to a permanent increase in inflation but only to a change in relative prices. A related implication is that, 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.

Although inflation expectations seem much better anchored today than they were a few decades ago, they appear to remain imperfectly anchored. ...

[Research finds that, not counting shocks, the variability of inflation] appears to have fallen significantly after about 1983. That is, unexpected changes in inflation are today much more likely to be transitory than they were before the early 1980s. Because it seems quite unlikely that changes in inflation could persist indefinitely unless long-run expectations of inflation also changed, I interpret [this] finding as consistent with the view that inflation expectations have become much more anchored since the early 1980s."

The gist of his speech is that inflation is more stable since the early 1980s, and therefore the public's expectations of inflation are more stable, so the public's expectations are "much more anchored." Therefore, things like energy price shocks don't have long-lasting effects.

Dear reader, this speech is total, utter, absolute drivel. Bernanke has NO IDEA where inflation expectations help or hurt the economy, or have any effect on the economy at all. He presents some research on what happened in the 1990s, but that research didn't apply before the 1990s, and he has NO IDEA whether it applies today. Total absolute drivel.

Ben Bernanke at Princeton
Ben Bernanke at Princeton

You know, I used to comment on Alan Greenspan's speeches all the time. He said things I agreed with and things I disagreed with, but what he said always was interesting and insightful and intelligent. Greenspan was born in 1926, lived through the horrors of the Great Depression and World War II, and knows a lot about how the world works.

Bernanke was born in 1953, and knows little of how the world works. I rarely comment on Bernanke's speech because he comes across to me as an airhead. He may have been a Princeton professor of Economics, but that obviously doesn't qualify him to actually know anything.

Let's recall a couple of things that Bernanke has said in the past, as I explained in my 2005 essay, "Ben S. Bernanke: The man without agony," Bernanke doesn't believe in bubbles. He thinks that the Great Depression could have been avoided by a few Fed policy changes (mostly having to do with inflation, incidentally, which probably explains why he talks about it so much today).

When speaking about America's astronomical and exponential growing debt to other countries in March, 2005, Bernanke blamed America's debt on "global savings glut" in other countries.

As dumb as that was, it wasn't the dumbest thing that Bernanke has said. I think that the dumbest thing is his belief, as laid out in a speech he made on October 7, 2004, that the Fed strongly influences the stock and bond markets merely by publishing the Open Market Committee minutes earlier and more often. He doesn't believe that fundamentals have anything to do with the economy; all that matters is what the Fed SAYS, and that's important because it affects what investors think. Bernanke believes that what matters is what people expect.

That's why he gave this moronic speech on Tuesday. In his tortured mind, the state of the economy depends on the public's expectations of what inflation will be.

And the stock market? He doesn't believe in bubbles. He doesn't believe that price/earnings ratios matter. All that matters is what people expect, and that depends on what the Fed says.

As I explained at length in my comprehensive analysis of macroeconomic theory that I wrote last year, "System Dynamics and the Failure of Macroeconomics Theory," economists have been wrong about everything, at least since the start of the bubble in 1995. They didn't explain or predict the bubble or its timing. They failed to predict low inflation or high unemployment in the early 2000s. They didn't predict or explain productivity increases. They didn't predict or explain the low interest rate "conundrum." They didn't predict or explain the housing bubble. They've been consistently wrong about almost everything.

During the 1930s, huge numbers of businesses were wiped out and forced into bankruptcy. The businesses that survived only did so by completely renewing themselves, essentially making themselves new businesses.

The reason that inflation was so unstable in the 1970s is because all those businesses reached their peak in the 1960s and 1970s, producing top-notch products that everyone wanted. The demand for these products pushed prices up, leading to high inflation.

The reason that inflation is so stable now is because all those 1930s businesses are now encrusted in bureaucracy, and are no longer producing products that people want. This has caused tens of thousands of factories to shut down, as jobs fled to China; even service businesses ended, as service jobs fled to India. The low demand for American-made products has forced inflation to near-zero, despite oil price shocks.

The reason that the dot-com bubble occurred in the 1990s was because it occurred at precisely the time that all the risk-averse financial managers who had grown up during the Great Depression disappeared (retired or died), all at once, and were replaced by airhead Baby Boomers who abused credit in a debauched fashion. This has led to the situation we see today, where the housing bubble is having a domino effect that will cause tens of millions of people to lose their life savings.

But all this appears to be lost on Bernanke, who's worried about what the American public expects about inflation. It's like a cartoon.

I don't know what to make of Bernanke. Can he really be as dumb as he seems? He's said stupid things in the past, but surely he can't be so oblivious to what's coming.

As I wrote the other day, it's now evident that there are many high-level financial managers who know that we're headed for a massive financial crisis, but are afraid to say so because they're afraid of triggering it.

Maybe I've underestimated Bernanke; maybe he really knows what's going on, but just doesn't want to say anything. After all, one word from him would indeed be all the trigger that's needed. (11-Jul-07) Permanent Link
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