Bernanke Fills Greenspan's Large Shoes
From the February 18, 2007 Sunday Times (London)
February 20, 2007
by Irwin Stelzer
IN days gone by, share-price movements were recorded on ticker tape, bits of paper that were at times showered from skyscrapers on heroes being honoured in New York City's so-called ticker-tape parades. Were it not improper, and had paper tape not been made obsolete by electronic reporting, Ben Bernanke would be sitting in an open-top limousine, showered with ticker tape by adoring traders after his appearance before Congress.
"He hit it out of the park," said one trader, resorting to one of the sports analogies popular on the still-macho trading floor of the New York Stock Exchange.
Here's why. "Real activity ... expanded at a solid pace in 2006 ... The US economy appears to be making a transition ... to a more sustainable average pace of growth ... The weakness in housing-market activity ... does not seem to have spilt over to any significant extent to other sectors of the economy ... Consumer spending has continued to expand at a solid rate ... Inflation pressures appear to have abated ... The business sector remains in excellent financial condition ...
Overall, the US economy seems likely to expand at a moderate pace this year and next, with growth strengthening somewhat as the drag from housing diminishes."
It just doesn't get any better than the Fed chairman's statement from the point of view of investors. No surprise, then, that the bulls are routing the bears, despite weak retail sales, industrial production, and employment figures released on the final day of Bernanke's testimony.
That economic glow is in odd contrast with the national political gloom. The economy seems about as good as it can get. But the political life of America is a mess: the White House and Congress are battling over Iraq policy, a Democratic Congress is investigating the administration's handling of the pharmaceutical, oil, healthcare and other industries, and its reconstruction of Iraq and New Orleans.
Perhaps Americans have decided that what goes on in Washington is full of sound and fury, signifying merely that the great machine that is the US economy is impervious to the self-important posturings of the politicians who think they are guiding it. They have also decided that Bernanke can fill the large shoes left empty by Alan Greenspan.
With reason. His policy of raising and then freezing interest rates seems to have the economy gliding to a soft landing, despite the weakness in the housing sector.
Better still, there are signs that the housing market is stabilising. Sales of homes are no longer plummeting, mortgage applications are up, homebuyers' sentiment has improved, and the National Association of Homebuilders activity index is at its highest level since June. In the fourth quarter of 2006, house prices in 71 local markets rose, while prices in 73 markets fell. Average prices fell by a relatively moderate 2.7% during all of 2006.
David Lereah, chief economist of the National Association of Realtors, thinks the bottom of the housing market was reached in the fourth quarter of 2006. Given the still-high level of unsold inventory, that might be a bit optimistic.
More important than the upbeat tone of the chairman's remarks are the clues he gave to the rules that will guide him as he sets monetary policy. Bernanke expects real (after adjusting for inflation) GDP to increase between 2.5% and 3% this year and between 2.75% and 3% in 2008. It seems clear that he thinks growth in that range is about what the economy can sustain without triggering inflation. So, if growth falls below, say 3%, he might be inclined to cut interest rates, and to raise them if growth tops that level.
Second, he suggests that he is willing to live with an inflation rate of 2%, but no more, using the Fed's preferred measure of inflation (Personal Consumption Expenditures). So watch that indicator, and assume that Bernanke will get an itchy trigger finger if inflation persistently tops 2%, especially if the economy is pressing on capacity at that time.
Third, Bernanke's statement suggests that he believes that the level of unemployment at which there are neither too many jobs chasing workers, nor too many workers chasing jobs, is somewhere between 4.75% and 5%. (For the jargon-prone, that's the NAIRU, the non-accelerating inflation rate of unemployment).
This is carrying transparency to levels that would have sent nervous chills down the spine of his Delphic predecessor. Some critics feel Bernanke has gone too far, and given hostages to fortune. After all, decimal places were invented to prove that economists have a sense of humour, and it is not impossible that one end or another of those ranges will be pierced as a result of transitory events to which the Fed will not want to react by adjusting interest rates. But Congress is happy: one member said it was a relief to have a chairman who did not speak in tongues.
However, before buying a ticket for a dance with Rosy Scenario, do take notice of two things. First, the Fed chairman warned that the economy was operating at a high rate relative to its capacity, that tight labour markets and rising compensation might cut into profit margins, and that oil and other commodity prices were difficult to predict.
Second, the longer-term problems the economy faces are unsolved. The federal deficit remains high despite the high level of economic activity; the economy remains subject to an "oil shock", which its supplier-countries are quite capable of orchestrating; the ageing population will put strains on the pensions and healthcare programmes.
But that's for later, a period that will not be confronted until after a new president moves into the White House in January 2009.
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.