Bernanke on Economy's Wobble: Move Along, Nothing to See Here

In a speech on his U.S. outlook on Tuesday, the Fed chairman focused on price stability, saying that the recovery hasn't stalled

What really has Federal Reserve Chairman Ben Bernanke concerned? He provided some hints on Tuesday, speaking at the International Monetary Conference about the U.S. economic outlook. Considering the disappointing jobs report last week, falling home prices, and weakening consumer sentiment, you might think that he would have spent most of his time talking about challenges the recovery faces. Instead, however, he focused on why we shouldn't worry about commodity prices or inflation.

Just a Bump on the Road to Recovery

About the first quarter of Bernanke's speech was dedicated to his outlook for U.S. growth. Essentially, he hasn't changed his view. He still expects the recovery to be slower than everyone would like. Although the economic indicators have been somewhat rotten lately, this fits into the narrative of an uneven, "frustratingly slow" recovery.

The economy has taken a step back recently for two main reasons, according to Bernanke. One is the increase in commodity prices, which has taken a toll on consumer sentiment and spending. The other is supply chain issues in Japan stemming from the nation's severe earthquake. Since he expects both of these effects to dissipate in coming months, he believes that the U.S. economy to proceed forward at a brisker pace later this year.

Of course, there are real headwinds that will keep the recovery slower than we'd like, says Bernanke. One big one is housing. In most recoveries, this sector helps to create jobs. It isn't this time around. Public sector troubles, stemming from budgetary woes on federal, state, and local levels, will also slow the pace of the recovery.

In this context, he also addresses Washington's recent concern with deficits. He says the key is "to move quickly to enact a credible, long-term plan for fiscal consolidation" (his emphasis). Immediate budget cutting could threaten the recovery, but putting a plan in place now to cut deficits in the years to come will assure investors that the U.S. will return to a sustainable fiscal path. 

Inflation and Prices

Surveying his speech, it appears that about 60% focused on prices (as the word cloud above helps to show). Bernanke took time to explain why he still considers inflation to be under control, despite recent jumps in gasoline and other commodity prices. He had two central reasons. First, the U.S. labor and product markets aren't operating at full strength, so demand won't drive prices much higher. Second, inflation expectations haven't changed, which is to say that investors don't expect prices to rise aggressively in the months or years to come. He also took comforting in data that suggests that oil and commodity prices have declined slightly in recent weeks.

The largest section of Bernanke's speech is dedicated discussing commodity prices. He provides reasons for why their increase isn't due to monetary policy, but other factors such as stronger demand for some goods by emerging markets. He argues that the Fed's monetary policy is not responsible for higher commodity prices, so it would not be appropriate for the Fed to tighten money supply in response to their rise.

Fed to Stay the Course

With that said, he also doesn't see the Fed expanding monetary policy again anytime soon. He believes that the recovery is on course, despite recent indications that appear to suggest otherwise. That's why he continues to support ending the Fed's latest round of asset purchases this month, while leaving the other accommodating policies in place indefinitely. Perhaps this is his speech's most telling paragraph, in terms of his philosophical approach to monetary policy:

The U.S. economy is recovering from both the worst financial crisis and the most severe housing bust since the Great Depression, and it faces additional headwinds ranging from the effects of the Japanese disaster to global pressures in commodity markets. In this context, monetary policy cannot be a panacea. Still, the Federal Reserve's actions in recent years have doubtless helped stabilize the financial system, ease credit and financial conditions, guard against deflation, and promote economic recovery. All of this has been accomplished, I should note, at no net cost to the federal budget or to the U.S. taxpayer.

This statement is fascinating, because it's both humble at one point and arrogant at another. First, Bernanke admits that the Fed's ability to fix a broken economy is limited. It can help but it alone cannot quickly restore millions of jobs. This is a message to the public: have realistic expectations of what the Fed is capable of accomplishing.

With that said, however, he asserts that the Fed has accomplished an awful lot. It stabilized the financial system, fought off deflation, and created an environment conductive to recovery. And it worked like magic, because all this benefit was provided at no cost to Americans.

But perhaps that last sentence should have ended "yet" or "so far." The Fed's biggest challenge lies ahead. It's easy to put out a fire with piles of money. But at some point, the Fed will have to reduce the enormous size of its balance sheet at a pace that will both allow the economy to march forward undisturbed and avoid higher inflation. Considering the unprecedented, aggressive action taken by the Fed over the past three years to provide enormous amounts of monetary stimulus, that won't be an easy balance to strike.