Tuesday, October 25, 2005

Ben Bernanke

It's old news now, but I want to do a round-up of what's been said. I would have done this last night, but I'm still not feeling my best.

Don Luskin predicted on October 17th,
You know, maybe it's not all this talk about inflation that has spooked stocks these last few weeks. Maybe investors are worried that President Bush will nominate someone to replace Alan Greenspan as Fed chairman next year who believes that inflation can be controlled by leeches or bleedings — or by human sacrifice.

Let's hope Bush chooses wisely. If his choice is a man or woman who understands the simple truth that inflation is caused by too much money chasing too few goods, then the stock market will say, "Thank you, Mr. President," with a wonderful and well-deserved rally.
And Don was right, listing various news headlines about yesterday's rally. Even after today's expected profit-taking, the major indices were down only slightly. The DJIA was down -7.13 (-0.07%), the NASDAQ fell -6.38 (-0.30%), and the S&P 500 lost -2.84 (-0.24%).

But some financial writers just don't get it. This AP article is headlined "Dow Sheds 7 on Falling Consumer Confidence" but says in the first paragraph:
NEW YORK Oct 25, 2005 — Wall Street closed lower in profit-taking Tuesday after the previous session's big gain, though the market held on reasonably well despite a surprising drop in consumer confidence and a disappointing forecast from Texas Instruments Inc.
So which is it? The headline blames the fall in consumer confidence, yet the article says the slight decline was despite the news.

While waiting yesterday morning for Bush to make the nomination, I read Russell Robert's Cafe Hayek entry on Bush nominating his tax accountant to head the Fed. Had I not realized immediately it was a satire, I would have had a heart attack. It's no less than brilliant: how does one criticize a politician's actions without specifying them?

On a serious note, Tyler Cowen of Marginal Revolution extolled Bernanke as a macroeconomist who has contributed important work. Cowen's main emphasis is Bernanke's commitment to price stability.

Larry Kudlow had some great insight:
In my view it is a good choice. Though Mr. Bernanke is not a hardcore advocate of the price rule, he does favor an inflation target, which is the second best option. Noteworthy is the fact that in recent speeches he has emphasized the slow and steady 2 percent zone of core inflation and inflation less energy. So he is not as militant as some of the crazed Fed presidents....

Bernanke will also support an extension of Bush’s tax cuts for capital gains and dividends, and he has told me in the past that raising tax rates would only harm the economy....

Thank heavens that Fed board member Donald Kohn, who is a demand-sider and a Phillips Curver, did not get the nod.
In his follow-up, he made a very important point:
The cause of inflation is excess money creation by the Fed—not rapid economic growth, nor too many people working, nor temporary oil shocks, nor hurricanes.
He and Don Luskin are hardly Austrians, but like Milton Friedman, they agree with Milton Friedman that inflation is strictly a "monetary phenomenon." I addressed this briefly some months ago in "What is 'free'? And what is 'inflation'?"

Don had written in his aforementioned TrendMacro article:
OK, get this (and try not to laugh). According to the minutes, the Fed believes that all the government spending to rebuild the Gulf Coast will overheat the economy and cause inflation. Or in the Fed's arcane language, it will be "an increase in fiscal stimulus at a time when the margin of unutilized resources in the overall economy was probably thin."

The core idea here is that prices across the economy will be driven up by people competing for scarce resources required for rebuilding — construction labor, building materials, and so on. Well, maybe some prices will be driven higher, at least temporarily. It's not too much of a stretch to think that the price of cement or lumber will be higher for a while. But more people wanting wood and cement isn't inflation — it's just supply and demand. Inflation is when the Fed prints too much money, and the price of goods denominated in that debased currency rises in response. But that's not the way some of the econometric gurus at the Fed see it. They believe that rising consumer demand causes inflation. That means they believe that prosperity causes inflation. They believe that jobs cause inflation.
Usually it's Austrian economists who drive home the point that the Federal Reserve is the sole cause of true inflation.

As Don Boudreaux of Cafe Hayek explained,
Because the Fed largely controls the supply of U.S. dollars, the Fed's role isn't to "tame" inflation. Rather, the Fed's role simply is not to generate it. It can achieve this goal very, very easily -- namely, by not increasing the money supply.

This is no difficult task.

But the popular account of inflation still portrays inflation not as something caused by excessive monetary growth but as some alien-like demon, or animal spirit, that visits us from time to time and needing "taming" by smart and brave central bankers.

Too often, things that are simple -- for example, not causing inflation -- are treated as though they are challenges of the first rank, while things that are impossibly complicated -- for example, government provision of health care -- are treated as though they are quite easy to achieve.
Indeed. Here is wisdom.

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