Fed quandary

US jobs: The drop in the US unemployment rate to 10 per cent from 10.2 per cent is not unalloyed good news for Ben Bernanke. The Federal Reserve chairman this week cited rising job losses to quell calls from inflation hawks for higher interest rates that would fight soaring commodity prices and potential future inflation. But if commodities continue strong, the arguments for cheap money will soon wear thin.

The details in this month’s employment report, together with an unexpectedly strong rise in October factory orders, suggest the U.S. economy as a whole may finally have turned the corner. The greatest strength was in temporary jobs, up 52,000. These generally come with fewer benefits than permanent positions, so it’s possible the uncertainty over the Obama administration’s healthcare and tax policy is driving employers towards greater use of contract labor.

Meanwhile, construction, manufacturing and information technology, generally higher-paying sectors, all continued to lose jobs, but at a slower rate. The average work week ticked up, but average hourly earnings rose only 1 percent annualized, well below the rate of inflation.

In written testimony to Congress on Thursday, Bernanke said the Fed remained “committed to its mission to help restore prosperity and to stimulate job creation while preserving price stability”. In response to questions, he also said that he did not see any extreme asset price trends in the United States, but that foreign governments must be responsible for their own asset bubbles.

That didn’t address the question of frothy markets for commodities, whose prices are globally determined. Nor did it resolve the sometimes hidden conflict between the Fed’s twin objectives under the 1978 Humphrey-Hawkins Act of fighting both unemployment and inflation. When inflationary signals appear while unemployment is high, the conflict between those objectives is thrown into sharp focus.

If unemployment continues to decline, Bernanke will lose a powerful argument for keeping short-term interest rates at their current exceptional near-zero levels. At that point, further rapid increases in commodities prices could leave him and his Fed colleagues little option but to finally start raising rates.