Greenspan’s Inflation

Discussion in 'Wall St. News' started by curis, Jun 13, 2006.

  1. curis


    Ben Bernanke jolted the stock market last week with his remarks Monday on inflation. At one point Thursday the Dow Jones Industrial Average was down nearly 500 points from where it began the week. Outside the stock market, Mr. Bernanke’s tough talk on rising prices elicited warnings from the National Association of Realors and a number of Wall Street economists, none of whom are delighted by the prospect that Mr. Bernanke might take away the proverbial punch bowl.

    Last Tuesday, the Realtors lowered their sales forecasts for the year and told Mr. Bernanke enough was enough. The truth is , we have some inflation in the system. And with a new Fed chief-especially one who, before succeeding Alan Greenspan, made a name for himself by talking about dropping money out of helicopters to stem deflation–it is essential that the Fed not erode its credibility as an inflation-fighter. Year-over-year inflation figures don’t look alarming yet, but shorter-term price indexes are creeping up and forward-looking market indicators such as commodity prices continue to climb.

    In a sign the Fed is trying assiduously to dampen expectations that the rate-hiking cycle is over, several Fed Governors echoed the Chairman’s comments last week, including Vice Chairman-designate Donald kohn, who told the U.S. Senate Thursday that recent rises in price indexes were “unwelcome.” Mr. Bernanke will need their support as the chorus to end the interest-rate increases surely will grow louder in the coming months.

    The Fed did the right thing by cutting rates after the dot-com crash and continuing after 9/11, when business investment tumbled. This gave the housing market a lift and allowed consumers to keep the recession mild. But even after the economy tarted to gain steam, the Fed remained fixated on the specter of deflation, underestimating the pro-growth effects of the 2003 investment tax cuts. The rising inflation with which Mr. Bernanke must now grapple can beseen as Alan Greenspan’s git to his successor.

    Mr. Bernanke played a role here too, however. He was still warning about deflation as late as mid-2003. So there’s some justice in the fact that he’s the one who has to clean up a mess he helped create. But cutting rates is alwasys politically easier than rising them, so it will take fortitude not to stray from the path the Chairman laid out last week.

    As last week’s market action attests, the stock market doesn’t much like talk of higher rates. But the history of the 1970s shows that elevated inflation is far more damaging to equities prices that are rate hikes. The market and the economy will be better off if Mr. Bernanke and the Fed get back to neutral rates before inflationary expectations take root in the behavior and expectations of the businesses and individuals. The new Fed chief last week put himself in a tough but necessary position. If he doesn’t want to go down in history as the next Arthur Burns, he’ll just have to tough out the screaming and stay the course.