Federal Reserve Chairman Ben S. Bernanke’s testimony to Congress shows concern over deflation, according to Marvin Goodfriend, an economist at Carnegie Mellon University and a former Richmond Fed policy adviser.
In his semi-annual report on monetary policy yesterday, Bernanke told the Senate Banking Committee that central bankers are ready to act as needed while the economic outlook remains “unusually uncertain.” Bernanke reiterated the comments today before the House Financial Services Committee.
The Fed chairman’s choice of the word “unusually” signals the central bank is “worried primarily about an extended downside risk” to the economy, Goodfriend said during a radio interview today with Tom Keene on Bloomberg Surveillance.
“I think this is an entirely original phrase,” said Goodfriend, who teaches at Carnegie Mellon’s Tepper School of Business in Pittsburgh. “I can understand the poetry.”
Even with a double-dip recession unlikely, the Fed could face a contraction in labor markets and deflation as productivity outpaces demand for goods and services, according to Goodfriend.
The deflation scare of 2003 was “kind of a dress rehearsal for the situation we’re in today,” Goodfriend said.
The Fed is dealing with a “situation we haven’t seen for decades,” said Goodfriend, citing the near-zero interest rates of the 1930s during the Great Depression.
Policy makers have kept the target for overnight loans between banks in a record-low range of zero to 0.25 percent since December 2008. They trimmed growth forecasts for this year and next at the Federal Open Market Committee’s June meeting, according to minutes released July 14.
The consumer price index slipped 0.1 percent in June for a third straight monthly decrease, according to Labor Department data. The so-called core rate, which excludes food and energy prices, increased 0.2 percent, exceeding the 0.1 percent gain projected by the median forecast of economists surveyed by Bloomberg News. The year-over-year core rate rose 0.9 percent.
“We haven’t seen any of these things very much alone, let alone together,” the professor said.
Given unemployment near 10 percent and growing, Goodfriend said the Fed should take action if it finds “outright deflation” in the consumer price index.
The Fed’s near-zero interest rates and record balance sheet are already “very stimulative,” Bernanke said yesterday in the testimony. Possible options “if the recovery seems to be faltering” include amplifying the commitment to low borrowing costs, while cautioning that officials haven’t fully reviewed the measures.
To position itself against deflation risks, Goodfriend said the note the Fed should announce it’s ready to take its balance sheet “well beyond $2 trillion by buying long-term Treasury securities with newly created bank reserves, if the Fed determines that is needed.”
The Fed must convince markets it’s willing to take the risk of overshooting on deflation and creating some inflation, Goodfriend wrote.
While the Fed has the tools to aid the economy, a full recovery may require more than monetary policy, Goodfriend said.
“It seems to me that the key to getting the recovery moving is to break the knot by which individuals with cash are unwilling to take a position, a risky position for fear that they would be taxed or decapitated should they earn outsized rewards from taking that position,” Goodfriend said.
Labeling Bernanke “surgeon general of economics,” Goodfriend said it’s the chairman’s job “to break that impediment to the recovery.”