Doug wrote: > Not exactly. The markets were > very disappointed with Bernanke's > testimony yesterday because he > made it sound as if another rate cut > is not imminent. Should things > really unwind, they'll undoubtedly > change their mind, but the message > they're sending now is no rate cuts > unless the econ data look really bad.
In his testimony, Bernanke emphasized the possibility of both a contraction *and* inflation. Why is he doing this? Isn't he being reckless or stupid? Wouldn't it have helped him better to issue an obscure statement a la Greenspan? I don't know. In my opinion, Bernanke is trying to accomplish two things. One, he's trying to show the big players that he means it when he speaks of transparency. He's willing to show the Fed's hand, to the best of his current (but evolving) understanding of the situation. And, two (as a case in point), he's saying, "Look, we need a quick but comprehensive repricing of risk and a resetting of expectations so that credit can flow and the economy can resume a more normal course. It's going to hurt anyway, but it'll hurt the least if we do it quickly but thoroughly. Then and only then will I be free to move rapidly, tackle inflation, and slow down the USD decline. It's up to you how quickly we can proceed and leave the episode behind." It's not a terrible policy. Politically, that'd be ideal for them. But, of course, it's full of risks, since panic -- within the country and abroad -- could set in and force his hand under political pressure. The insulation ("independence") of the central bank from popular pressure would be tested at a point when the discontent against both major parties is very high and as the country heads to a presidential and congressional election. Even if the central bank remains insulated, fiscal monkey wrenches can be thrown into the mechanism of monetary policy by the legislative branch. With all the international shocks feeding into it (Pakistan, Iran, etc.), the whole dynamics of the presidential election can become less predictable than it now appears. In any case, the fact that Bernanke decided that he cannot downplay either scenario, contraction or inflation, indicates how narrow his wiggle room is. (Sabri will speak for himself, but it seems to me that his remark on the CP article was not meant to criticize it for emphasizing the direst scenarios, but rather to defend the posing of those scenarios as sensible -- i.e. as *probable*. The certainty the author of the article displays may make the piece a bit too strident to our stylistic tastes, but the fact that things are in flux doesn't mean that all scenarios are equally likely. Not at this point.)