Bernanke’s Press Conference Dished Out Plenty Of BS

Federal Reserve Chairman Ben Bernanke held the first-ever news conference by a Federal Reserve Chairman. The move was an obvious effort to calm financial markets after a string of unsettling news. Some of the questions asked during this Q&A session were actually quite good; others were merely softballs. Financial markets generally took the bait, and all appears to be calm again. However, this calm reaction is entirely incorrect.

Chairman Bernanke helped the expected boredom by saying pretty much nothing. News about the Federal Reserve usually does not get mainline America stirring, and this news conference was no exception. But, a lot could and should have been said, as there are plenty of challenges to be addressed.

Here is the recent news that triggered the news conference. One of these events involves the S&P negative outlook on the U.S. debt rating. The S&P outlook generated the following from Mr. Bernanke:

In one sense S&P’s action didn’t really tell us anything because everyone who reads the newspaper knows that the United States has a very serious long-term fiscal problem. That being said, I hope that this event will provide at least one more incentive for Congress and the administration to address this problem. I think it’s the most important economic problem, at least in the long run, that the United States faces. We currently have a fiscal deficit that is simply not sustainable over the longer term, and if it’s not addressed it will have significant consequences for financial stability, for economic growth, and for our standard of living… To the extent that the S&P action goads response, that’s constructive.”

Quantitative easing (QE) is an unconventional monetary policy used by the Federal Reserve to stimulate the economy. Under QE, the Federal Reserve (aka Fed) buys government bonds with new money that the central bank creates (i.e., prints). This increases the money supply and the reserves within the banking system. This purchasing raises the prices of the Treasury instruments bought, which in turn lowers the yield. In November 2008, the Fed initially announced a $600 billion QE program, but then increased that to $1.8 trillion four months later. In November 2010, the Fed announced a second round of bond purchases (called QE2), totaling $600 billion in long-term Treasuries over the next eight months, plus $250 billion to $300 billion reinvested in Treasuries with the proceeds of its earlier investments.

Unfortunately, inflation and the risk that inflation will increase, is a far greater problem than the Fed is admitting.  So why are Americans feeling their wallets pinched so much lately at the gas and food stores when the CPI-U is relatively low?  One important answer lies in the government’s statistics. According to the BLS, “the CPI is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services”. Thus, the CPI is designed to measure the cost of a fixed basket of goods, comparing apples to apples to accurately measure (i) returns on investments relative to inflation, and (ii) the standard of living one can afford on a given income relative to inflation. However, since the late 1970s, the BLS changed how it measures the CPI “basket” 24 times.

By substituting product and quality improvements, the inflation rate can be artificially decreased. For example, if the price of steak increased “too much”, the price of hamburger or something “comparable” would be substituted into the CPI. As a result, the CPI has changed from measuring inflation relative to a given standard of living to measuring inflation relative to a declining standard of living. If the original methods (those prior to the late 1970’s) were still used today, today’s CPI would be approximately 10 percent. The chart below shows the CPI-U (red line) as measured by the BLS’s continually changing measurements and the alternate CPI (blue line) as measured using BLS’s “original” method.  The following chart shows that Americans’ are justified in feeling that prices are rising and inflation is actually already here.

Among other reasons, the CPI is important because it is used by the Fed to justify its monetary policy. Mr. Bernanke’s answer to a pointed question about the Fed’s monetary policies causing inflation expectations was dubious at best.

Well, we view our monetary policies as being not that different from ordinary monetary policy. It’s true that we used some different tools, but those tools are operating through financial conditions and we have a lot of experience understanding how financial conditions, changes in interest rates changes in stock rates, so on, how they affect the economy, growth, et cetera. We are monitoring the state of the economy, watching the evolving outlook and our intention as is always the case is to tighten policy at the appropriate time to ensure that inflation remains well controlled; that we meet that part of our mandate while doing the best we can to ensure also that we have a stable economy and a sustainable recovery in the labor market. So the problem is the same one that Central Banks always face, which is choosing the appropriate path of tightening at the appropriate stage of the recovery. It’s difficult to get it exactly right, but we have a lot of experience in terms of what are the considerations and the economics that underlie those decisions. So we anticipate that we will tighten it at the right time and that we will thereby allow the recovery to continue and allow the economy to return to a more normal configuration; at the same time keeping inflation low and stable.” [Emphasis added]

Nothing could be further from the truth.  In our longer article on this subject, we show charts created by the Fed that show the real state of affairs.  There is nothing “ordinary” about these Fed charts.  We also provide a prescription for what the Fed should be doing to avert a larger crisis.

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