If we can fool the public, there's no inflation, Fed chief says

Anchored Expectations Mute Price Swings, Bernanke Says

By Scott Malone
Reuters
Tuesday, July 10, 2007

http://www.reuters.com/article/ousiv/idUSWAT00785520070710

CAMBRIDGE, Massachusetts -- Swings in volatile energy and food prices will have minimal impact on inflation as long as expectations of future price gains are held steady, Federal Reserve Chairman Ben Bernanke said on Tuesday.

"If inflation expectations are well anchored, changes in energy (and food) prices should have relatively little influence on 'core' inflation, that is, inflation excluding the prices of food and energy," Bernanke told the National Bureau of Economic Research.

Some analysts have suggested policy-makers may need to pay more attention to broad measures of inflation that include food and energy, given recent persistence of gains in these prices.

However, Bernanke appeared to side with the Fed's long-standing practice of focusing more heavily on core price measures in setting monetary policy.

His remarks shed little light on how the Fed views the economy or how it might move interest rates in the future.

"Inflation is less responsive than it used to be to changes in oil prices and other supply shocks," he said.

At the same time, Bernanke said the Fed must consider how jumps in food and energy costs might affect other prices when it attempts to discern where inflation is heading.

"Forecasts of core inflation must take into account the extent to which food and energy costs are passed through to other prices," he said.

...Expectations the key

Bernanke, who presents the Fed's semiannual report on monetary policy to Congress next week, said the extent to which inflation expectations are held steady has "first-order implications" for what happens to inflation and the economy.

One of the reasons inflation is now more stable than in the past in the face of swings in demand is that inflation expectations are now better anchored, he said.

"A one-off change in energy prices can translate into persistent inflation only if it leads to higher expected inflation and a consequent 'wage-price spiral,'" he said.

When the Fed forecasts inflation, it distinguishes between the outlook for the next three to six months and the time horizon beyond that, Bernanke said.

"For all the advances that have been made in modeling and statistical analysis, practical forecasting continues to involve art as well as science," he said.

At its last meeting on June 27-28, the Fed decided to hold the benchmark federal funds rate steady at 5.25 percent, the level it reached more than a year ago.

In announcing their decision, policy-makers said that while readings on core inflation had improved modestly in recent months, they were waiting for further evidence that price pressures have subsided for good.

As it has for several months, the Fed once again pointed to a tight labor market as a potential source of upward pressure on prices.

Bernanke said in response to questions later that the Fed aims to come forward in the "reasonably near future" with proposals on improving the way the bank communicates its deliberations with the public.

He may provide more details about the Fed's debate on communications, which have included discussion of setting numerical targets for inflation, when he appears before lawmakers July 18-19.

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