Last Bernanke Years Shows No Sign of Buyer’s Remorse
U.S. markets are backing up Ben S. Bernanke’s assertion that he has the best inflation record of any Federal Reserve chairman since World War II.
Since Bernanke took office in February 2006, inflation as measured by the personal-consumption-expenditures price index has averaged 1.9 percent. Criticism from Republicans, including House Speaker John Boehner of Ohio, that the Fed’s stimulus would spark a rapid acceleration in prices is unfounded, bond yields show. Traders anticipate prices will rise at a 2.17 percent rate in the next decade, near the Fed’s 2 percent goal.
“There’s a pretty pervasive expectation that inflation rates remain reasonably stable,” said Keith Hembre, chief economist at Nuveen Asset Management in Minneapolis, which manages about $120 billion. “Certainly, there are a number of critics, but if you just look at the performance of the market and the measure of financial conditions, at least here over the near-term you’d conclude the policies have been successful.”
How Bernanke’s unprecedented monetary stimulus will be perceived by historians ultimately depends on whether the Fed can attain its goal of price stability once the economy gains momentum, said Hembre, a former researcher at the Minneapolis Fed. “Judgment day hasn’t come yet.”
“A critical part” of the next Fed chairman’s job “is making sure that we keep inflation in check,” President Barack Obama said at an Aug. 9 White House news conference. He also reiterated that Bernanke’s successor must continue trying to reduce unemployment, as “the challenge is we’ve still got too many people out of work.”
Bernanke, whose second term ends in January, has swelled the central bank’s balance sheet to a record $3.65 trillion through three rounds of so-called quantitative easing. The bond buying has increased the quantity of bank reserves in the system as policy makers direct the markets desk at the Federal Reserve Bank of New York to purchase securities from primary dealers, or brokers who are authorized to trade directly with the central bank. This adds funds to the dealers’ accounts and creates reserves at their clearing banks.
The surge in excess reserves “may mean nothing” for inflation, said James Paulsen, chief investment strategist at Wells Capital Management in Minneapolis with more than $342 billion under management as of March 31. “If they never leave the Federal Reserve building, why does it matter? There’s a part of me that really believes that, but we don’t know.”
While some observers once regarded Alan Greenspan as the world’s greatest central banker, his legacy has been tarnished because the U.S. entered the worst financial crisis since the Great Depression in 2007, the year after Bernanke’s predecessor left the Fed.
Bernanke, who won’t attend the Kansas City Fed’s annual economic-policy symposium on Aug. 22-24 in Jackson Hole, Wyoming, has said the central bank will stop the economy from overheating by relying primarily on its ability to pay interest on the cash it holds for banks.
Bond markets are showing confidence in the Fed’s ability to succeed: Debt traders anticipate prices will accelerate at a 2.17 percent rate during the next decade as measured by the break-even rate for 10-year Treasury Inflation Protected Securities, a yield differential between the inflation-linked debt and Treasuries that measures projections for consumer prices over the life of the securities.
“He’s not going to be viewed as the unwitting architect of a ruinous series of price inflation,” said John Lonski, chief economist at Moody’s Capital Markets Research Group in New York. “I just don’t see that happening, and the TIPS -- they don’t see that happening either.”
Five-year break-even rates, at 1.8 percent on Aug. 16, have fallen from 2.47 percent in April 2011, when inflation expectations climbed after the Fed announced QE2 in November 2010. The $600 billion of bond purchases sparked the harshest political backlash against the central bank in three decades from Republicans, including Boehner and former Representative Ron Paul of Texas. Economists such as Stanford University’s John B. Taylor also said QE2 showed no evidence of working and risked stoking inflation.
The surge in prices has yet to materialize. Inflation reached 2.9 percent in September 2011 -- the highest since October 2008, the month after Lehman Brothers Holdings Inc. collapsed -- and has since fallen to 1.3 percent, based on the personal-consumption-expenditures price index.
Bernanke bragged about his inflation record in response to being called “the biggest dove” since World War II by Senator Robert Corker, a Tennessee Republican, during a Feb. 27 Senate Banking Committee hearing.
“You called me a dove. Well, maybe in some respects I am,” Bernanke said. “But on the other hand, my inflation record is the best of any Federal Reserve chairman in the post-war period or at least one of the best.”
Lonski said he sees inflation as “well-contained, indefinitely” because wages aren’t growing by more than 2 percent annually.
The Fed chairman still faces “a lot of mixed feelings” because his unconventional policies may have “opened Pandora’s box” for activism, Paulsen said. It’s also questionable how much the Fed’s bond buying has helped the U.S. economy, he said.
While Bernanke has boasted about his record on price stability, he has failed to attain the central bank’s other goal: full employment. The jobless rate was 7.4 percent in July, still above the 5 percent rate when the recession began in December 2007 although down from a peak of 10 percent in October 2009.
And just because inflation hasn’t picked up thus far doesn’t mean it won’t, which may damage Bernanke’s legacy, said Stephen Stanley, chief economist at Pierpont Securities LLC in Stamford, Connecticut. Stanley has criticized the Fed’s policies and said he expected prices to accelerate faster than they have.
“Where Bernanke is subject to a pretty big reassessment is twofold: on maintaining the crisis stance of policy for far too long” and whether “the Fed’s faith in their exit strategy will prove to have been wise or misguided,” Stanley said.
Bernanke said in February that policy makers are reconsidering their earlier plan to sell bonds as part of a tightening strategy. The Fed chairman said no country has ever had a comparable increase in the size of its portfolio and unwound it “in the precisely analogous way.”
He has called the ability to pay interest on reserves “the principal tool that we contemplate” for withdrawing stimulus. The Fed gained this tool in 2008 and has never used it to tighten policy.
“I still have my doubts on the degree to which the Fed is going to be able to exit the stance of policy in an orderly way,” Stanley said. He pointed to the “pretty dramatic move in markets” that resulted from a “pretty subtle shift” earlier this year when Bernanke outlined on June 19 the conditions that would prompt the Fed to reduce and ultimately end asset purchases.
Bernanke’s remarks pushed the yield on the benchmark 10-year Treasury to a 22-month high and erased $3 trillion in value from global equity markets over five days. The Standard & Poor’s 500 Index of stocks has climbed 29 percent to 1,655.83 (SPX) from 1,282.46 on Feb. 1, 2006, the day Bernanke became chairman.
The Fed is buying $85 billion of bonds a month, and policy makers are weighing whether the economy has improved enough to warrant scaling back their stimulus. Bernanke said in June they may reduce the purchases later this year and halt them around mid-2014 if economic performance improves as projected.
Fed officials expect the economy to grow 2.3 percent to 2.6 percent this year and 3 percent to 3.5 percent in 2014, according to the central tendency estimates of policy makers’ June forecasts, which exclude the three highest and three lowest.
“Once we get back to the point where the economy is fully employed, there’s a lot of fuel there that could potentially stoke a more meaningful risk in inflation,” Hembre said. “We don’t have the dynamics in place for that to happen here in the near-term.”
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