Bernanke speaks: (Full text) In my opinion, this is a major speech, and therefore I quote more extensively today than usual. You really should read it all.
It is reasonably clear that the U.S. economy is entering a period of transition. For the past three years or so, economic growth in the United States has been robust, reflecting both the ongoing re-employment of underutilized resources as well as the expansion of the economy’s underlying productive potential, as determined by factors such as productivity trends and the growth of the labor force. Although we cannot ascertain the precise rates of resource utilization that the economy can sustain, we can have little doubt that, after three years of above-trend growth, slack has been substantially reduced. As a consequence, a sustainable, non-inflationary expansion is likely to involve some moderation in the growth of economic activity to a rate more consistent with the expansion of the nation’s underlying productive capacity. It bears emphasizing that productivity growth seems likely to remain strong, supported by the diffusion of new technologies, capital investment, and the creative energies of businesses and workers. Thus, productive capacity should continue to expand over the next few years at a rate consistent with solid growth of real output.
...A slowing of the real estate market will likely have the effect of restraining other forms of household spending as well, as homeowners no longer experience increases in the equity value of their homes at the rapid pace seen in recent years.
Gains in payroll employment in recent months have been smaller than their average of the past couple of years, and initial claims for unemployment insurance have edged up. These developments are consistent with the softening in the pace of overall economic activity that seems to be under way. That said, going forward, relatively low unemployment and rising disposable incomes may counter to some extent the factors tending to restrain household spending.
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Consumer price inflation has been elevated so far this year, due in large part to increases in energy prices. Core inflation readings--that is, measures excluding the prices of food and energy--have also been higher in recent months. While monthly inflation data are volatile, core inflation measured over the past three to six months has reached a level that, if sustained, would be at or above the upper end of the range that many economists, including myself, would consider consistent with price stability and the promotion of maximum long-run growth. For example, at annual rates, core inflation as measured by the consumer price index excluding food and energy prices was 3.2 percent over the past three months and 2.8 percent over the past six months. For core inflation based on the price index for personal consumption expenditures, the corresponding three-month and six-month figures are 3.0 percent and 2.3 percent. These are unwelcome developments.
...Finally, some survey-based measures of longer-term inflation expectations have edged up, on net, in recent months, as has the compensation for inflation and inflation risk implied by yields on nominal and inflation-indexed government debt. As yet, these expectations measures have remained within the ranges in which they have fluctuated in recent years, but these developments bear watching.
With the economy now evidently in a period of transition, monetary policy must be conducted with great care and with close attention to the evolution of the economic outlook as implied by incoming information. Given recent developments, the medium-term outlook for inflation will receive particular scrutiny. There is a strong consensus among the members of the Federal Open Market Committee that maintaining low and stable inflation is essential for achieving both parts of the dual mandate assigned to the Federal Reserve by the Congress. In particular, the evidence of recent decades, both from the United States and other countries, supports the conclusion that an environment of price stability promotes maximum sustainable growth in employment and output and a more stable real economy. Therefore, the Committee will be vigilant to ensure that the recent pattern of elevated monthly core inflation readings is not sustained.
Toward this end, and taking full account of the lags with which monetary policy affects the economy, the Committee will seek a trajectory for the economy that aligns economic activity with underlying productive capacity. Achieving this balance will foster sustainable growth and help to forestall one potential source of inflation pressure. In addition, the Committee must continue to resist any tendency for increases in energy and commodity prices to become permanently embedded in core inflation. The best way to prevent increases in energy and commodity prices from leading to persistently higher rates of inflation is by anchoring the public’s long-term inflation expectations. Achieving this requires, first, a strong commitment of policymakers to maintaining price stability, which my colleagues and I share, and, second, a consistent pattern of policy responses to emerging developments as needed to accomplish that objective.
David Altig updated his probability charts after the employment report last Friday. The fed funds futures market, as I have said before, is getting whiplash. Today's remarks by Bernanke will likely spin the market back in the other direction. The IEM, on the other hand, has remained remarkably calm. As for my take, I think Bernanke's words were appropriate for the situation. I have not wavered from my assertion that another increase this month is more likely than not. The IEM puts the odds at about 60:40. I'd put an increase as even a little bit more likely than that. Not a sure thing, but despite the gyrations that data dependence has caused, I'm staying the course.
In the coming days there will be much to talk about, I am sure.
UPDATE: Whiplash, indeed. This just in from Reuters.
Short-term interest rate futures markets took the comments to mean the Fed was more likely to lift rates at its policy-making meeting this month, moving prices to imply a 76 percent chance of another hike from less than 50 percent before the speech. U.S. stock and bond markets also declined.
Read on.
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