No inflation if people don't expect it, Bernanke tells Harvard grads

Bernanke Sees No Repeat of '70s-Style Inflation

By Jeannine Aversa
Associated Press
via Yahoo News
Wednesday, June 4, 2008

http://news.yahoo.com/s/ap/20080604/ap_on_bi_ge/bernanke;_ylt=Ar1khDJzMS...

WASHINGTON -- Federal Reserve Chairman Ben Bernanke said Wednesday he does not believe the United States will experience the out-of-control prices seen with 1970s oil shocks.

His assessment came in a speech delivered Wednesday to graduating students at Harvard University, where he earned a bachelor's degree in economics in 1975.

Back then, the economy suffered from a dangerous combination of stubborn inflation and stagnant growth. There are fears today that the U.S. may be heading in that direction again.

"We see little indication today of the beginnings of a 1970s-style wage-price spiral, in which wages and prices chased each other ever upward," Bernanke said at Harvard.

Then, as now, the U.S. endured a serious oil price shock, sharply rising prices for food and other commodities, and subpar economic growth, he said.

Today's economy, however, is more flexible in responding to difficulties and the country is more energy efficient than a generation ago, Bernanke said.

"Since 1975, the energy required to produce a given amount of output in the United States has fallen by half," he said.

Over the years, Fed policymakers also have learned more about inflation and how to fight it, he said.

Bernanke's remarks come just one day after he said that the Fed's rate-cutting campaign was coming to an end because of increasing concerns about inflation. He took aim at the role of the weakened dollar in pushing prices higher. It was a rare public pronouncement by a Fed chairman about the U.S. greenback.

The Fed is paying attention to the extent to which consumers, investors and businesses believe prices will rise in the future. Monitoring those "inflation expectations" are important. If people believe inflation will keep going up, they will change their behavior in ways that aggravate inflation -- thus, a self-fulfilling prophecy.

"Some indicators of longer-term inflation expectations have risen in recent months, which is a significant concern for the Federal Reserve," Bernanke told the Harvard students. "We will need to monitor that situation closely."

Changes in current inflation expectations have been measured in just "tenths of a percentage point" as opposed to "whole percentage points" in the mid-1970s, he said. That highlighted the difference between how people now and then viewed inflation.

Paychecks today are shrinking as rising prices bite into them. In the 1970s, people were demanding -- and getting -- higher wages in anticipation of rapidly rising prices; hence, the "wage-price" spiral Bernanke cited.

The inflation rate has averaged about 3.5 percent over the past four quarters. That is "significantly higher" than the Fed would like but much less than the double-digit inflation rates of the mid-1970s and 1980, Bernanke said.

Paul Volcker, Fed chairman in the 1980s, broke inflation's grip by raising interest rates to the highest levels since the Civil War. That approach, however, plunged the country into a painful recession in 1981-82.

Bernanke and other Fed officials have put inflation higher on their current list of concerns. But the economy remains fragile, buffeted by housing, credit and financial crises.

To help brace the economy, the Fed dropped interest rates in late April to 2 percent, a nearly four-year low, and continued a rate-cutting campaign that started last September. Bernanke suggested Tuesday that the Fed would not be inclined to cut rates further given inflation concerns.

Many economists believe the Fed will hold rates steady at its next meeting on June 24-25 and probably through much, if not all, this year. But some believe that inflation could flare up and force the Fed to begin boosting rates later this year or in 2009.

Despite the pain in people's purses, the economy as a whole has "thus far dealt with the current oil price shock comparatively well," Bernanke said. Challenges remain, he added, "in dealing with rising global demand for energy, especially if continued demand growth and constrained supplies maintain intense pressure on prices."

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