There is more work ahead to control inflation

WASHINGTON – Former Federal Reserve Chairman Ben Bernanke, who led the central bank and the US economy through the Great Recession, believes that central bankers still need to work to bring down inflation.

That work, he and economist Olivier Blanchard argue An academic paper released TuesdayIt will entail slowing what used to be an exceptionally flexible labor market.

The duo offer no specific prescriptions for how much unemployment should rise, but they suggest that it is possible for the current Federal Reserve to orchestrate its way out of this impasse without severely damaging the US economy.

“Looking ahead, with labor market sluggishness continuing below sustainable levels and inflation expectations slightly elevated, we conclude that it is unlikely that the Fed will be able to avoid a slowdown in the economy to return inflation to target,” Bernanke and Blanchard wrote in the paper.

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

Their paper notes that inflation has evolved since it swelled to a 40-year high in the summer of 2022. At first, prices jumped as consumers used stimulus from Congress and the central bank to shift spending from services to goods, causing supply jams and an era of inflation. . .

However, they note that the new phase is now being driven by rising wages trying to catch up with the rise in prices. The good news is that such shocks are generally manageable, but they said the Fed needs to continue trying to address the employment situation where the unemployment rate is 3.4% and there are still about 1.6 available jobs for every available worker.

“The portion of inflation that has its origin in overheating labor markets can only be reversed through policy measures that better balance supply and demand for labor,” Bernanke and Blanchard say.

Nonetheless, the paper is more about why headline inflation as measured by the CPI was above 9% last year as it goes from here.

Most economists agree that the combination of trillions in government spending combined with zero interest rates and nearly $5 trillion in bond purchases from the Federal Reserve has flooded the economy with money and created distortions that have driven up prices.

At a forum presented by the Brookings Institution on Tuesday, Bernanke, Blanchard and other prominent economists and academics discussed root causes and what policymakers should do as they review their future policies.

Among the considerations were supply and demand factors, the extent to which Covid itself affects consumer decisions, and whether a new policy framework adopted by the Federal Reserve in September 2020 that seeks not only full employment but also “broad and inclusive” played a significant role. role in economic dynamics.

“Quantitatively, the biggest sin was fiscal policy, particularly for 2021. But the least forgiving sin was monetary policy,” said Jason Furman, former chair of the Council of Economic Advisers and Harvard University economics professor.

He added, “I have lower expectations for fiscal policy. When they get the right signal, I’m pleasantly surprised.” “Monetary policy has made the mistake again and again and meeting after meeting… I have higher expectations of the Fed than just getting the right signal.”

With inflation rising beyond the Fed’s 2% target, policymakers insisted on calling the trend “temporary” and did nothing but begin to discuss when it would reduce its bond purchases. The Fed only started raising interest rates in March 2022, a full year after its preferred measure of inflation exceeded the target.

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

Former Fed Vice Chairman Richard Clarida, who sat on the FOMC during the inflationary boom, said the policy missteps are not attributable to over-commitment to the policy framework adopted in 2020, which came amid racial unrest across the country. He called the Fed’s reluctance to tighten policy “a mistake of tactics, not of strategy” and attributed it to the “fog of war”.

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

“No central bank in an advanced economy has started raising interest rates until inflation has passed the target,” Clarida said. “Why this happened, obviously, is a very important and interesting question that tells us more about central banks’ inflation-targeting practice in the field than it does about any particular implementation of a framework.”

Bernanke Blanchard’s paper points to the inherent danger of allowing central banks to continue inflation for too long and the impact on price expectations.

“The longer the overheating period, the stronger the catch-up effect, the weaker the entrenchment of expectations, the greater the impact of labor market tightening on inflation, and, by implication, the stronger the eventual monetary deflation required to bring inflation back to target, all else being equal.”