It’s worth taking a quick read through the February 15 testimony of new Federal Reserve Chairman Ben Bernanke before the House Committee on Financial Services.
No, really!
Why? Well, though they might not often think about it, entrepreneurs, small businesses and their employees need to understand monetary policy. It impacts their businesses, jobs and all other aspects of economic life. And after 18 years of Alan Greenspan at the helm, it is important to get a read on Bernanke.
Most important, Bernanke clearly explains why price stability matters: “Inflation prospects are important, not just because price stability is in itself desirable and part of the Federal Reserve's mandate from the Congress, but also because price stability is essential for strong and stable growth of output and employment. Stable prices promote long-term economic growth by allowing households and firms to make economic decisions and undertake productive activities with fewer concerns about large or unanticipated changes in the price level and their attendant financial consequences.”
The Fed chairman also was upbeat about the economy in general: “The U.S. economy performed impressively in 2005. Real gross domestic product (GDP) increased a bit more than 3 percent, building on the sustained expansion that gained traction in the middle of 2003. Payroll employment rose 2 million in 2005, and the unemployment rate fell below 5 percent. Productivity continued to advance briskly. The economy achieved these gains despite some significant obstacles. Energy prices rose substantially yet again, in response to increasing global demand, hurricane-related disruptions to production, and concerns about the adequacy and reliability of supply. The Gulf Coast region suffered through severe hurricanes that inflicted a terrible loss of life; destroyed homes, personal property, businesses, and infrastructure on a massive scale; and displaced more than a million people… However, the most recent evidence--including indicators of production, the flow of new orders to businesses, weekly data on initial claims for unemployment insurance, and the payroll employment and retail sales figures for January--suggests that the economic expansion remains on track.”
And what about inflation? Bernanke was generally positive, but warned: “In the announcement following the January 31 meeting, the Federal Reserve pointed to risks that could add to inflation pressures. Among those risks is the possibility that, to an extent greater than we now anticipate, higher energy prices may pass through into the prices of non-energy goods and services or have a persistent effect on inflation expectations. Another factor bearing on the inflation outlook is that the economy now appears to be operating at a relatively high level of resource utilization. Gauging the economy's sustainable potential is difficult, and the Federal Reserve will keep a close eye on all the relevant evidence and be flexible in making those judgments. Nevertheless, the risk exists that, with aggregate demand exhibiting considerable momentum, output could overshoot its sustainable path, leading ultimately--in the absence of countervailing monetary policy action--to further upward pressure on inflation.”
Of course, the Fed has to keep its eyes on economic developments, including, most assuredly, energy prices. But Bernanke follows the tradition of monetary authorities to talk about utilization rates, aggregate demand, and output overshooting “its sustainable path.” This kind of analysis is off base and misleading.
Economic growth does not cause inflation. In reality, inflation is a purely monetary phenomenon, that is, too much money chasing too few goods. More growth and production do not cause inflation, but instead, fight inflation.
Always keep in mind, that when inflation accelerates, it ultimately is not about energy prices or moving beyond sustainable growth. Instead, it’s about the Fed getting monetary policy wrong.
Raymond J. Keating
Chief Economist
Small Business & Entrepreneurship Council
February 17, 2006
