The testimony of Federal Reserve Chairman Bernanke this morning chronicles the very difficult and very fluid situation which confronts policymakers. Policy makers confront an economy bedeviled by tight credit, falling home prices ,a soft labor market and an unenthusiastic business sector. The headwinds are strong indeed and Bernanke noted that the risks are skewed to the downside and that he expected growth to be appreciably below trend the remainder of this year. He also suggested that the recovery in the following two years would be gradual. However, the Committee remains vigilant regarding a resurgence of inflation and they are particularly concerned that the inflationary expectations might become embedded in the domestic wage price structure.
Bernanke did spend quite a bit of time discussing the price of oil and the supply demand factors which have caused the price to surge. He laid much of the “blame” at the feet of emerging market economies and the demand from those countries as they establish modern industrial states.
On the supply side he noted inadequate investment as a reason that supply lags and he noted that geopolitical risks have constricted supply.
He also took a swipe at the head-in-the-sand crowd who suspect that speculators are responsible for the surge in prices. He said that a little more information and transparency was a good thing but he thought that it would not significantly move the price of the underlying commodity.
On balance I think that the speech is on the dovish side. He made the case that the economy would be sluggish, in effect, for several years. On the inflation side he noted that that a secondary effect of higher oil prices has yet to emerge. He also noted that we have not seen the requisite rise in inflationary expectations which might force some action from the Federal Reserve.
In that regard, it is hard to imagine what action which they might take in light of the very fragile condition of the economy. Any action which restrains the growth of credit currently would be an act of financial immolation.