Page 2 of 2 Bernanke blighted by tunnel vision
By Hossein Askari and Noureddine Krichene
depreciation, they caused capital flight. Because of negative savings and
falling external financing, real investment has fallen. The deflationary effect
of high inflation, in form of deep cuts in real consumption and investment, has
set in reverse multiplier and acceleration effects which caused real GDP growth
to decline.
The Pigou real balances effect has been widely used in national income models
to explain the impact of changes in price level on real income, namely a rising
price level is seen to depress real income, albeit with a delay, and
vice-versa. Empirically, cheap money policy has created short-lived booms,
which turned into prolonged busts as soon as savings started to decline and
inflationary expectations became strongly footed. Real income
gains during the boom are wiped out in the bust phase. Jacques Rueff (1964)
argued that excessive credit can push an economy to starvation.
Bernanke's explanation for rising oil prices was also faulty. To quote:
The
price of oil currently stands at about five times its level toward the
beginning of this decade. Our best judgment is that this surge in prices has
been driven predominantly by strong growth in underlying demand and tight
supply conditions in global oil markets. Growth has been concentrated in
developing and emerging market economies, where energy consumption has been
further stimulated by rapid industrialization and by government subsidies that
hold down the price of energy faced by ultimate users. On the supply side,
despite sharp increases in prices, the production of oil has risen only
slightly in the past few years.
Although main emerging
countries were running large external current account surpluses (for example,
China at 8% to 10% of GDP), Bernanke blamed these countries for higher oil and
food consumption. He omitted an important fact that none of the developing or
emerging countries has a reserve currency of its own. Whereas the US and other
currency countries (such as the euro zone and Japan) can always import oil by
issuing money out of thin air, oil imports of emerging countries are purely
constrained by their ability to earn or borrow reserve currencies. On the
supply side, oil output rose by 10 million barrels a day (mbd) to 87 mbd in
2008 from 77 mbd in 2001. Whether this increase is only slight depends on how
big an increase Bernanke had in mind.
Again Bernanke was deflecting attention from a destabilizing monetary policy.
Prices cannot increase by fivefold without a supporting increase in
liquidities. Huge US external deficits, negative real interest rates and
massive bailouts created abundant liquidities and a flight toward commodities.
Noting that oil prices have more than doubled since August 2007, and food, gold
and other commodities prices were under the same pressure, only an aggressive
re-inflationary policy of the Fed could be accountable for hyper commodity
inflation.
A dollar glut creates commodity price inflation and a dollar shortage has
depressed commodity prices. The International Energy Agency has established
that world oil demand has been fully contained in real terms and has even
started to edge lower. However, huge dollar liquidities from deficit financing
and bailout money, falling exchange rates, and negative interest rates kept
pushing oil and other commodity prices upward, in spite of declining real
demand.
While consumers are suffering painful cuts in their food and basic amenities
consumption due to faster rising prices for food, rent, gas, utilities, and
healthcare, Bernanke has been self-congratulating that "core inflation" was
always at 2%. Core inflation is defined to exclude food and energy prices. If
food and energy are excluded, what makes the rest a core?
This concept of fictitious core inflation has become so futile that no one
should take it seriously. No one knows what it measures, how it is generated,
why it is always stacked at 2%, while inflation has been raging at double-digit
rates according to independent sources.
For instance, the Reuters-CRB Index showed that inflation accelerated to 25.4%
per year in the period from September 2007 to June this year from 14.5% per
year in the May 2003 to September 2007 period.
The concept of core inflation is a blurring device. While inflation is taking a
toll on real incomes, imposing a prohibitive tax burden and bringing the
economy to a halt, official statistics continue to underestimate inflation.
Relying on alternative measures, such as core inflation, they continue to show
absolute price stability at 2% a year, while many countries are already
suffering two digit inflation. Policymakers have to agree on producing only one
measure of consumer price index (CPI), which includes most relevant household
expenditures.
On a change of policy, Bernanke adopted a wait-and-see position in his
testimony. To quote him:
The FOMC will be carefully evaluating incoming
information bearing on the economic outlook and will act in a timely manner as
needed to support growth and to provide adequate insurance against downside
risks.
So far, there seems to have been not been enough
information for Bernanke to make a move! In spite of deteriorating indicators -
national savings negative, inflation taking a toll, economy slowing down,
unemployment rising, external capital fleeing, dollar collapsing, oil and food
prices soaring - the Fed as well as the George W Bush administration does not
have enough information requiring actions to put in place a stabilization
program.
It would appear that inflation and sustained economic growth are not a priority
for Bernanke and the FOMC. The un-stated goal is to maintain cheap money policy
to finance fiscal deficits and protect Wall Street interests. The public has to
be taxed through inflation and bear the real burdens of fiscal deficits and
bailout plans.
The present financial crisis has been considered by prominent figures as the
worst crisis since the 1930s, and it continues to only worsen. Real-income
gains enjoyed in 1983-2000 are being quickly eroded by an accelerating and
taxing inflation. It is unfortunate that such a monumental crisis had to happen
when prominent economists, who studied the causes of earlier financial crises
and the monetary history of the US, warned against the dangers of a cheap-money
policy.
Milton Friedman warned that the Fed could fall under the arbitrary power of a
small group of men not subject to control by the electorate. He explained what
the Fed cannot do and what it can do. He showed that the Fed couldn't peg
interest or unemployment rates. However, the Fed can, and should, control money
supply and credit.
Semi-annual testimonies before Congress in past years did not help thwart the
present financial crisis. Bernanke's recent testimony, by masking faulty money
policy, will not ward off deteriorating prospects either. Interest-rate setting
by the central bank is a form of price control that causes monumental
inefficiencies and distortions. Setting interest rates at a very low level can
depress economic growth.
It is high time for Congress to say enough is enough with regards to
unpredictable and destabilizing monetary policy. It is high time to restore
rule-based, stable and predictable monetary policy, and safe central banking
practice to the US. If not, there will be a long period ahead of even deeper
economic decay, worsening inflation, and financial disorder.
Hossein Askari is professor of international business and international
affairs at George Washington University. Noureddine Krichene is an
economist at the International Monetary Fund and a former advisor, Islamic
Development Bank, Jeddah.
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