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From Chairman Bernanke’s July 07 speech:

As you know, the control of inflation is central to good monetary policy. Price stability, which is one leg of the Federal Reserve’s dual mandate from the Congress, is a good thing in itself, for reasons that economists understand much better today than they did a few decades ago. Inflation injects noise into the price system, makes long-term financial planning more complex, and interacts in perverse ways with imperfectly indexed tax and accounting rules. In the short-to-medium term, the maintenance of price stability helps avoid the pattern of stop-go monetary policies that were the source of much instability in output and employment in the past. More fundamentally, experience suggests that high and persistent inflation undermines public confidence in the economy and in the management of economic policy generally, with potentially adverse effects on risk-taking, investment, and other productive activities that are sensitive to the public’s assessments of the prospects for future economic stability. In the long term, low inflation promotes growth, efficiency, and stability–which, all else being equal, support maximum sustainable employment, the other leg of the mandate given to the Federal Reserve by the Congress.

Note that the current anti-‘inflation’ argument within the FOMC is that the high prices for imports take discretionary income from consumers that reduces domestic demand and reduces the ability to service domestic debt. There was no thought or mention of that reason for ‘inflation’ being a ‘bad thing’ a year ago.

I suppose one could argue that this problem is due to there not being inflation, as with wages ‘well-anchored’ there is only a relative value story. If we did have ‘real inflation’ with rising wages, we wouldn’t have the problem of insufficient consumer income to support domestic demand, but we would have the traditional negatives from inflation.

But Bernanke’s response to Congress was that exports are replacing domestic consumption and that is a ‘good thing’ as it brings the US trade back to ‘balance’ and restores ‘national savings’ – the old mercantilist, gold standard imperatives. But it does leave weak domestic demand and rising prices. That brings us back to the tail end of Bernanke’s statement:

Admittedly, measuring the long-term relationship between growth or productivity and inflation is difficult. For example, it may be that low inflation has accompanied good economic performance in part because countries that maintain low inflation tend to pursue other sound economic policies as well. Still, I think we can agree that, at a minimum, the opposite proposition–that inflationary policies promote employment growth in the long run–has been entirely discredited and, indeed, that policies based on this proposition have led to very bad outcomes whenever they have been applied.

Seems that either way you look at it, rising prices (whether you call it inflation or not) lead to ‘bad’ outcomes.

And it sure looks to the dissenters in the FOMC that this is exactly what is happening. Only time will tell, but all Fed speakers now agree the risk of inflation is elevated substantially, and we will soon see if they still agree the cost of letting the inflation cat out of the bag is far higher than letting a near-term recession run its course and (hopefully) contain prices and keep a relative value story from turning into an inflation story.

Also, not how the Fed continues to use ‘other tools’ for market functioning as Bernanke just now indicates they will keep lending directly to their primary dealers.


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