A Fallible Fed
Newsflash: Bernanke not omniscient
Federal Reserve Board Chairman Ben Bernanke has quickly learned that the Fed chief never gets a day off. There is always someone trying to get inside your head. Bernanke's, (and by extension the Fed's) thoughts on inflation drove a skittish Dow Jones to a 500-point sell-off last week. Now this week the release of new inflation numbers by the Labor Department has the potential to roil markets even more. What is Bernanke to do?
Shut up is pretty sound advice. But beyond that—"stop talking" is actually what long-time Fed-watcher Allan Meltzer counseled—the totally unrealistic expectations heaped upon America's central banker need to be adjusted down to the merely extraordinary. Ben Bernanke is, by all accounts, a smart economist, but he did not gain super-human powers when he took over the Fed. He is just another imperfect government official trying to do a job the best he can.
Bernanke is not, however, blameless for the current situation. Following in the footsteps of Joey Ramone, Bernanke allowed himself to be smitten by CBNC reporter Maria Bartiromo and let slip his private inflation fears at a glitzy DC shindig in April. Maria ran straight to the airwaves with her scoop, underscoring the fact that nothing the Fed chairman ever says is really, really off-the-record, setting off a mild market swoon, and intensifying the Bernanke brain-watch.
That casual misstep is totally on the new Fed chairman, tripped up by a failure to appreciate just how much every tidbit of gossip drives trading decisions from Canberra to Edinburgh. That shouldn't happen again, and Bernanke has said it will not.
A much bigger deal was the release of the May 10 minutes of the Federal Open Market Committee, the Fed's policy setting group. Released two weeks ago they revealed that someone on the committee, a Fed governor or perhaps Bernanke himself, thought that inflation was enough of a threat that a half-point hike in the fed funds rate might be needed. This would be a change from the series of quarter-point hikes the Fed has pursued in recent months.
As an academic exercise, the change is perhaps not a big thing to wonder about. But in the context of Fed's ongoing battle against inflation and Wall Street's unfamiliarity with Bernanke, the half-point musing hit financial pros between their eyes. Did the half-point view mean that inflation was really twice as bad as the Fed had thought? Worse, was there no longer any of the famed Greenspan consensus about the money supply? Was the Fed split? The sky falling? My bonus in jeopardy?
Such reaction was far too emotional. In reality, the problem is the mistaken view that the Fed has perfect insight into the economy at all times and will always be able to "guide" policy to a "soft-landing." It is an oddly misplaced faith in central planning from people who make their lives in the middle of market-driven chaos.
But at the same time it was clumsy for the Fed board to entertain the half-point idea given Bernanke's status as an unproven central banker. It would be akin to a doctor who has steadfastly prescribed an ointment wondering in front of a jumpy patient if what that stubborn rash really needed was surgery. The Fed does not manage the economy so much as it manages expectations about the economy.
And it is the realm of expectation where the markets have backed themselves into a corner with little help from Bernanke or the Fed. Somewhere along the line the suspicion that the Fed's current round of rate hikes would end by mid-year hardened into a firm belief, then an article of faith. Now we've reached the point where even a couple more quarter-point hike rate turns would be taken as a reversal of Fed policy, rather than a continuation of the current path.
Overseas, it is taken as an iron rule of monetary policy that central bankers ease going into elections. This expectation is not of Bernanke's making, but he still must confront it heading into the third-quarter of 2006 and somehow "prove" he does not like the horrors of inflation.
At its core, a word-and-deed conflict trips up the expectation game. The markets both want the Fed to actively fight inflation and say that the inflation the Fed is fighting is not really a threat. It is a delicate distinction that Bernanke has to master to avoid surprising the markets further. And the markets could help matters immensely by accepting the fact that Bernanke, like any human being, will occasionally do something surprising.
After all, everybody wants the same things: Low inflation, steady growth, a stable currency. And Maria Bartiromo hanging on our every word.