What he said…and what he didn’t
The Fed will be pleased with the Bernanke performance at the press conference. He did not send any obvious confused signals. He embellished on the policy notes in the Fed’s policy statement. He clarified that his remarks were meant to reflect the committee and to reflect divisions where they existed. He took responsibility for his own remarks. It was a stand up and professional performance. He made the Fed’s decisions to continue to maintain the size of its portfolio and to complete the QEII process the feature of this presentation. He followed that with a discussion of the Fed’s outlook. Then he took questions.
Stylized facts and the Fed’s stable inflation expectations hypothesis
The Fed’s Q&A went smoothly. But there were some issues of interest. This is always the case at a press conference. A written statement is controlled but in answering questions sometimes an undiscovered truth slips out. For example, the Chairman toed the line on the notion of inflation expectations being stable except for late in the Q&A when he let it slip that inflation expectations had risen somewhat. This of course did not get into the FOMC statement. Such an admission is the hobgoblin of all Fed fears. As pat of the Fed’s written text it would have an explosive impact. But in the flow of the Q&A give-and-take the impact is different. Bernanke admitted this in a context of an answer to a related question; he actually said that expectations are up a little and that the Fed has some limitations in what it can do. So this is something that the Chairman said and at the same he did not say it. He said it in a context that allowed it to slip by, as part of a response to a different question. But like a ticking bomb in an Alfred Hitchcock movie that the audiences sees and no one else is aware of, it is there in the background, ticking away.
What this reveals is that the FOMC statement and minutes are caricatures of the economy or if you prefer a presentation of ‘stylized facts’. The Fed does not portray each variable exactly as it is but in the way that the Fed construes it sort of Alice in Wonderland style ("When I use a word, it means just what I choose it to mean -- neither more nor less." -Humpty Dumpty). So if expectations are a bit elevated but not so much that they are a ‘clear’ problem the Fed may choose to continue to refer to them as subdued or anchored even as the moorings are loosening. The Fed has made it clear that it is not going to be as preemptive as its rhetoric once-sounded. It is willing to see expectations slip a bit because it is relatively more worried about high unemployment. For that reason it will accept the risk that is implied by the up-creep in expectations. On direct questioning Bernanke would never admit this trade off but it is implicit in what he said and the way he responded in the Q&A session. This is precisely the problem with adoption of a dual mandate, it creates dueling mandates and one keeps getting in the way of the other.
The question about the Fed’s role in the decline in the dollar came up; the Chairman deferred, saying that the Treasury Secretary is the spokesman for the dollar. That is correct. Then he added that the Fed was in favor of a strong dollar and a strong economy adding that to strengthen the dollar the Fed was keeping inflation low and acting to strengthen the economy.
The real fact is that the dollar is weak and that is boosting the economy. A weak dollar raises inflation risks as well. But it is true also that the dollar is in some sense not as much weak from the Fed’s actions as it is back to where it was before the financial crisis began. During the crisis a flight-to-quality boosted the dollar’s value then as recovery took place the dollar went back to where it was before the recession’s onset. It does not require any reference to the Fed’s low interest rate policy or to QE to explain it.