Dow Continues Dive After Fed Chief Expresses Inflation Concerns
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JEFFREY BROWN: Today, for the first time since March, the Dow Jones Industrial Average dipped below 11,000 points. The last month has been especially rough, from a 52-week high of 11,709 on May 10th, close to an all-time high, to today’s close at 11,002.
The big sell-offs yesterday and today followed comments from Ben Bernanke, now in his fifth month as chairman of the Federal Reserve.
The Fed has been raising interest rates steadily for the last two years, and there had been some hints that those hikes could be over. But yesterday, Bernanke’s tough talk about inflation got everyone’s attention.
BEN BERNANKE, Federal Reserve Chairman: Consumer price inflation has been elevated so far this year, due in large part to increases in energy prices. Core inflation readings — that is, measures excluding the prices of food and energy — have also been higher in recent months.
While monthly inflation data are volatile, core inflation measured over the past three to six months has reached a level that, if sustained, would be at or above the upper end of the range that many economists, including myself, would consider consistent with price stability and the promotion of maximum long-run growth.
For example, at annual rates, core inflation, as measured by the Consumer Price Index, excluding food and energy prices, was 3.2 percent over the past three months and 2.8 percent over the past six months. For core inflation based on the price index for personal consumption expenditures, the corresponding three-month and six-month figures are 3.0 percent and 2.3 percent. These are unwelcome developments.
JEFFREY BROWN: In his speech yesterday, Chairman Bernanke also noted signs of a slowing economy, including a cooling housing market and lower consumer spending.
Focusing on inflation
JEFFREY BROWN: For more on all this, we turn to Philip Jefferson, economics professor at Swarthmore College and a former research economist at the Federal Reserve Board.
Lee Hoskins, former president of the Federal Reserve Bank in Cleveland, now a senior fellow at the Pacific Research Institute.
And Hugh Johnson, chief investment officer at Johnson Illington Advisors.
Professor Johnson, starting with you, why don't you help us interpret Mr. Bernanke? What was he saying about inflation?
HUGH JOHNSON, Johnson Illington Advisors: Well, he's pretty much saying it as it is. He's just citing the facts, saying that we've seen some acceleration in price increases by companies to consumers. It started to pick up over the course of the last six months.
He's obviously very focused on it, very concerned about it, and implies -- doesn't state -- but implies that the Federal Reserve will respond to the fact that we're seeing some upward pressure on prices by raising interest rates even further.
It's probably the first least-ambiguous statement on inflation that we've heard from the chairman. So, very clear, he's worried about higher prices.
JEFFREY BROWN: Professor Jefferson, how do you interpret it? He used the words "unwelcome developments."
PHILIP JEFFERSON, Swarthmore College: Right, I think what Chairman Bernanke is trying to do in this particular situation is let the markets and the public know that he's aware of inflation; he's going to remain ever vigilant.
And at the same time, he's also in the position where he's trying to establish his inflation-fighting credentials; that is, he wants everyone to know that, even though Greenspan is not there at the helm anymore, he is still remaining ever vigilant.
He also noted that, in his view, the economy was operating a little bit above trend. So he's looking at a scenario where he hopes that the Fed can coax the economy down to its long-run trend growth rate and, at the same time, moderate the increases in inflation as a result to energy price changes.
So this is a very delicate operation that he's starting to undertake because he does not want to actually kill off the expansion.
The market's quick reaction
JEFFREY BROWN: Now, Lee Hoskins, why did what he said yesterday move the markets or shake the markets as it did?
LEE HOSKINS, Former President, Federal Reserve Bank of Cleveland: Well, the markets have a great deal of uncertainty in front of them, both about which direction the economy is going to go -- will it really slow to the extent that people think -- as well as will inflation rise or slow?
So the markets are faced with a lot of uncertainty, just as the Fed is, so we have new data coming in. We have a relatively new chairman. There's some difficulty, I think, that market participants are having in reading the chairman.
But the overall thrust is the chairman is doing what he ought to do, which is to guard against the worst error the Fed could make, which is to allow inflation and inflation expectations to become embedded in the economy. So I think the Fed's going to err and should err on the side of a restrictive policy.
JEFFREY BROWN: Now, Mr. Hoskins, you're saying you think he was right to raise a flag about inflation?
LEE HOSKINS: Oh, yes, I think it should have been raised sooner and I think it should be faced aggressively with policy action, including a discussion of a 50-basis point or half-percent increase at the next meeting.
JEFFREY BROWN: Mr. Johnson, what do you think about the timing of raising the flag over inflation?
HUGH JOHNSON: Well, I think he's quite right in pointing out that we're starting to see upward pressure on prices. I think it's important to note also that some of those technical indicators that we look at that tell us, not where inflation has been, but where inflation is going, have also risen a little bit and are a little bit troubling. They're not alarming; they're a little bit troubling.
So I think he's quite right in right now telling us that he's focused on inflation; he's quite right in trying to preserve the credibility of the Federal Reserve as an inflation fighter. Ultimately, that's going to be very good for the financial markets.
Short term, of course, the financial markets are very worried that the Fed will go too far or make a mistake and kill off the expansion. I don't think the Fed has gone that far yet, but nevertheless the markets are sending a message and that is that they're worried that the Fed ultimately may go too far. Right now, they haven't, but the markets are clearly worried.
Growth vs. inflation
JEFFREY BROWN: Well, Professor Jefferson, explain this sort of classic conundrum that Mr. Johnson just raised between fighting inflation on the one hand and fighting slow growth on the other, because they would call for different prescriptions, wouldn't they?
PHILIP JEFFERSON: Well, certainly it's the case that the mandate of the Fed is to maximize the potential for economic growth and monitor price stability.
But I think it's very important, Jeffrey, at this point in the business cycle to realize that this expansion is still not very deep, OK? There are particular pockets where employment is still not robust. You have the relatively unskilled still waiting to fully participate in this expansion.
And so I think it's a little too soon to go unambiguously towards an aggressive posture towards inflation, because there are still some employment gains for particular demographics in the society that we have yet to achieve.
JEFFREY BROWN: Mr. Hoskins, why don't you jump in there? You were at the Fed. How do you get that balance, when there is the downside that Professor Jefferson was just referring to?
LEE HOSKINS: Well, I don't think you can always achieve a balance; that's the point. Over time, the Fed affects one thing, and that's inflation or the price level. It does not affect the real economy, other than having a nice, stable, non-inflation environment.
So the Fed's main focus -- if it wants to have good employment numbers down the road -- needs to be on inflation. As I said before, nobody knows where inflation is going to go; they have forecasts, but nobody knows.
PHILIP JEFFERSON: Jeffrey...
LEE HOSKINS: The error that the Fed does not want to make is to allow inflation to get ahead of it.
PHILIP JEFFERSON: Jeffrey, may I jump in here a little bit?
JEFFREY BROWN: Go ahead.
PHILIP JEFFERSON: Because the statement that was just made that the Fed does not have real effects on the economy, I think the weight of the evidence is contrary to that, that, in fact, over a short- to medium-term horizon, Federal Reserve policy does affect real economic activity, including output and employment.
And so, certainly, Chairman Bernanke is well aware of this and he realizes that, while long-term price stability is the ultimate objective of the Federal Reserve, that in the medium run, it is possible for policy to have some impact on real economic activity.
Living up to the position
JEFFREY BROWN: Let me come back to something that I think you've all raised. Mr. Hoskins, you said that the markets were having some difficulty reading Mr. Bernanke. He's still quite new at the job. He says something yesterday; we see quite a large impact.
Did he mean to have that impact, do you think?
LEE HOSKINS: Oh, I don't think he meant necessarily to have that impact, in terms of that magnitude. I do think he meant to have an impact, to make it clear that inflation is a primary concern of the Fed and that, if it does its job right with respect to inflation, the economy will pretty much take care of itself.
JEFFREY BROWN: What do you think, Mr. Johnson?
HUGH JOHNSON: I think he's absolutely right, but I think the main thing is, before he took over as chairman, we knew -- we thought things would happen, is one is that he'd be, first of all, very focused on inflation, or at least more focused on inflation and, secondly, quote, "transparent" or less ambiguous.
I think he accomplished both of those things in what he said yesterday. He clearly preserved the credibility of the Federal Reserve as an inflation-fighter, told us that he was focused on inflation, at least now; and, secondly, it was absolutely unambiguous.
His statement was, shall we say, very, very transparent. We knew what he was saying. We have a very clear idea what's on his mind.
JEFFREY BROWN: Is there the fear, Mr. Johnson, that the markets, too, can overreact to things that the chairman says, particularly with a new chairman?
HUGH JOHNSON: Oh, absolutely, markets always overreact. They either go down too far or go up too far. They're not very efficient in that sense.
I don't know whether they've done that or not at this juncture. I think it's kind of important, though, to get the message of the markets right now.
And, clearly, the markets are worried that the Federal Reserve has raised interest rates. They're worried that the Federal Reserve may raise rates further and have an impact on the economy.
But the message isn't that it's going to be a significant impact on the economy; it's only that the economy is not going to be as strong as we previously had thought. And I believe that's showing up in the numbers right now for the second quarter and probably will show up in numbers for the third quarter.
JEFFREY BROWN: And, Professor Jefferson, how do you read what we're calling -- I'll call it the style question here for the new chairman?
PHILIP JEFFERSON: Well, I think it was very important from that perspective to do what he did yesterday, in that there's only so much of the Greenspan aura that one can hope to adopt for him or herself.
But, in Bernanke's case, he knows that establishing credibility is very important; he knows that transparency is very important. And so, again, he has to build his inflation credentials with the market so that, later on in his term as chairman, he will have more flexibility to do unorthodox things.
JEFFREY BROWN: And, Mr. Johnson, I know nothing's ever final looking at the markets and the economy, what are you looking at next? What's the next key number?
HUGH JOHNSON: Well, the next key number -- we have a whole set of numbers over the next couple of weeks that will tell us what the economy did in May. We know it slowed in the month of May, things like housing starts, industrial production, capacity utilization, income. They'll tell us that May was a slow month.
In response to the Consumer Price Index and Producer Price Index numbers for the month of May, which are also coming out, we'll get a pretty good idea what the Fed is going to do at their June 28th meeting. And right now, it looks pretty clear that they'll probably raise interest rates further or another notch, probably a 0.25 percent.
JEFFREY BROWN: All right, Hugh Johnson, Lee Hoskins, and Philip Jefferson, thank you, all three.
PHILIP JEFFERSON: Thank you for having me.