Start the conversation
By Jason Simpkins
Federal Reserve Chairman Ben S. Bernanke said yesterday (Wednesday) that he expects inflation to be "quite low for some time," but that the Federal Open Market Committee will begin publishing its long-term inflation forecasts to promote transparency.
A steep drop in commodities prices has dampened inflation expectations significantly in recent months. But despite declines in consumer and producer prices, the Fed's monetary base – the amount of total amount of a currency that is either in the hands of the public or in the central bank's reserves – has expanded by 80% in the past six months.
Meanwhile, the Fed's balance sheet has ballooned to $1.8 trillion in assets from $959 billion over the past year.
However, Bernanke argued yesterday that that many banks are opting to keep their capital on the sidelines and that "a significant shrinking of the balance sheet can be accomplished relatively quickly."
"Some observers have expressed the concern that, by expanding its balance sheet, the Federal Reserve will ultimately stoke inflation," Bernanke told journalists at the National Press Club. "The Fed's lending activities have indeed resulted in a large increase in the reserves held by banks and thus in the narrowest definition of the money supply, the monetary base. However, banks are choosing to leave the great bulk of their excess reserves idle, in most cases on deposit with the Fed. Consequently, the rates of growth of broader monetary aggregates, such as M1 and M2, have been much lower than that of the monetary base."
Bernanke added: "At this point, with global economic activity weak and commodity prices at low levels, we see little risk of unacceptably high inflation in the near term; indeed, we expect inflation to be quite low for some time."
Still, as credit markets and the economy begin to recover inflation could make a speedy recovery. Should that happen, the Federal Reserve will have to act quickly, something Chairman Bernanke says he is prepared for.
"The Federal Reserve will have to moderate growth in the money supply and begin to raise the federal funds rate. To reduce policy accommodation, the Fed will have to unwind some of its credit-easing programs and allow its balance sheet to shrink," he said. "A significant shrinking of the balance sheet can be accomplished relatively quickly, as a substantial portion of the assets that the Federal Reserve holds…are short-term in nature and can simply be allowed to run off as the various programs and facilities are scaled back or shut down."
To increase transparency and give the market a better sense of the Fed's expectations, the FOMC will publish long-term projections for the economy, particularly inflation.
The FOMC's projection of inflation over the next five years, he said, "may be interpreted … as the rate of inflation that FOMC participants see as most consistent" with price stability and maximum employment.
By releasing longer-term projections The Fed seems to be edging closer to an "inflation target," which is something already utilized by central banks in Europe, as well as an objective Bernanke himself lobbied for in the past.
The FOMC believes that the optimal inflation level over time between 1.7% 2%, according to the minutes from its Jan. 27-28 meeting.
The producer price index (PPI) rose 0.8% in January, after falling 1.9% in December the Labor Department said today. Core prices, which exclude food and energy, rose 0.4%. Consumer price data for January is scheduled for release tomorrow (Friday).
"It is doubtful that the price increases will be able to stick given the weakening economy and rising unemployment," James O'Sullivan, a senior economist at UBS Securities LLC told Bloomberg News. While "inflation hasn't collapsed yet, the big concern is still that inflation will fall too much."
News and Related Story Links:
- Federal Reserve:
Federal Reserve Policies to Ease Credit and Their Implications for the Fed's Balance Sheet
Credit easing won't stoke inflation, Bernanke says
- Money Morning:
Why Fed Policies and Treasury Department Bailouts Will Lead to Inflation Rather Than Deflation