Short-lived acclaim

Bernanke: Ben Bernanke could be in danger of becoming “person of the year” again in 2010 or 2011 – for less positive reasons than this time around. The Federal Reserve boss made the front of Time for his influence and for his possible role in heading off a depression. But he and the rest of the Federal Open Market Committee are in no hurry to lift interest rates despite the recovering US economy and signs of inflation. The risks in this approach are intensifying.

US producer and consumer price indices for November both showed upticks in inflation. Gold and commodity prices continue to be strong, with the CRB Index up 39 per cent compared with a year ago. That doesn’t seem to worry Bernanke and his colleagues. The FOMC statement on Wednesday stated that slack in the economy would keep inflation at bay.

In recent Senate testimony, Bernanke also said that recent increases in the gold price do not appear to reflect increases in expected future US inflation. Rather he pointed to other factors such as demand from electronics, auto and jewelry producers.

The Fed is betting heavily on Bernanke’s judgment. By any measure of inflation, short-term interest rates are substantially negative in real terms and getting more so. The future inflation rate implied by inflation-protected Treasury securities is now 2.55 per cent, against almost zero a year ago. The US central bank’s stance ignores these signals, and could fuel a rapid acceleration of inflation if upward pressure on prices turns out stronger than the FOMC anticipates.

Since the Fed believes that economic conditions warrant low interest rates for an “extended period,” there’s a danger it might not react quickly to further inflation signals as they appear. If not reversed, Bernanke’s low interest rate policy, acclaimed by Time as having prevented a “catastrophic depression,” could lead to something like stagflation, in which inflation takes off more quickly than monetary policy can control it.

Time is right in noting that Bernanke’s decisions matter. To the extent he is seen as having done the right thing so far, he should enjoy the adulation. It may not last.