Bernanke on the Grill

In the first day of his semiannual testimony, the Fed chief sticks to his guns on inflation while parrying lawmakers' pointed questions

What does Harry Potter have to do with monetary policy? Not much—except maybe on Capitol Hill, where the glib Barney Frank joked to the chairman of the Federal Reserve on July 18 that maybe rich people were "riding around on broomsticks" to avoid high gasoline prices.

So it went at the semiannual testimony by Fed chief Ben Bernanke to the House Financial Services Committee, which is chaired by Congressman Frank, a Massachusetts Democrat. Frank wasn't the only pontificator. You had to strain to catch any genuine information amid the highly political and sometimes tangential questions by members of Congress on both sides of the aisle.

The news—yes, there was some news—came in Bernanke's opening remarks, when he announced that the Fed was slightly lowering its forecast for 2007 growth from what it said back in February. The "central tendency" is for the economy to expand 2¼% to 2½% from the fourth quarter of 2006 through the fourth quarter of 2007, he said. That's down from a forecast of 2½% to 3% in February. He said the Fed was lowering its 2008 forecast by a quarter-point, to 2½% to 2¾%.

The Real Numbers

You might think the Fed would be more inclined to cut interest rates if it were lowering its growth forecasts. Don't count on it. In his testimony, the white-bearded oracle of money reiterated that the Fed regards inflation (not slow growth) as the central bank's "predominant policy concern." Notably, while cutting its growth forecast, the Fed didn't lower its inflation forecast at all.

Economists who are paid to read between the lines were most impressed by Bernanke's attention to "headline" inflation—i.e., overall inflation, including food and energy prices. The Fed tends to focus on "core" inflation, excluding food and energy, because it's not susceptible to random fluctuations. While core inflation has been fairly well-contained, and Bernanke expects it to trend lower, headline inflation matters as well. After all, it measures what real people are really paying.

Indeed, for once the "headline" grabbed the headlines. In his testimony on July 18, Bernanke said that the rate of headline inflation so far this year (4.4%), using the personal consumption expenditures deflator) "if maintained, would clearly be inconsistent with the objective of price stability."

Translation: Bernanke is going to keep money tight as long as inflation threatens to accelerate. On net, the testimony "complicates the timing of the Fed's eventual easing move," wrote David Rosenberg, North American economist for Merrill Lynch (MER).

Subprime Spillover

But there was something for the monetary doves to take away as well. Bernanke, well aware of Congress's concerns about the subprime mortgage mess, indicated that he's taking seriously the risk of spillover from subprime to other parts of the economy, though he doesn't see much yet. Bernanke said the Fed has launched a "top-to-bottom" review of measures to prevent another subprime meltdown.

"By actively addressing this topic, Bernanke tried to head off congressional criticism," wrote Harm Bandholz of UniCredit in New York. Action Economics analyst Michael Wallace wrote that the subprime remarks "skewed the debate toward the perception of downside economic risks."

The Fed chairman's appearance on Capitol Hill is always three parts theater to one part economics. Bernanke played his part correctly by sticking to his script while fielding every congressman's question or pronouncement politely. That's a skill that even Harry Potter might like to develop.

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