BERNANKE!
As markets fret, Bernanke struggles with rift at Fed
BARRIE McKENNA
Sunday, June 25, 2006
Washington — It's called the blackout period. In the week before and after a rate-setting meeting, the 12 members of the U.S. federal policy-making committee carefully avoid talking publicly about monetary policy.
Fed chairman Ben Bernanke has taken the informal rule one step further. Days before this week's pivotal meeting in Washington, Mr. Bernanke moved to consolidate his grip on the Fed byoverseeing the departures of two key voting members. Atlanta Federal Reserve Bank president Jack Guynn announced his retirement after a 42-year career at the bank, while Fed governor Mark Olson said he's leaving to head up a newly created accounting industry regulator.
The shakeup comes as Mr. Bernanke, who is nearing his six-month anniversary in the job, is struggling to convince investors that he's firmly in control of the U.S. central bank and its monetary policy. And some economists worry that an internal power struggle could cause the Fed to push too hard on the inflationary brakes with excessive rate hikes.
“There are signs that the board of governors is divided,” says Petter Lundvik, an economist at Handelsbanken Capital Markets of Norway. “It is not obvious that Ben Bernanke can take control over policy decisions that are formally taken by a vote. The struggle for power might result in the Fed raising rates too much, given the lags in monetary policy.”
Critics have already blamed Mr. Bernanke for precipitating recent turmoil in financial markets by confusing investors.
First, he suggested the Fed was poised to halt its two-year rate hike campaign.
And then days later, he reversed course by hinting that more hikes might be needed to tame burgeoning inflation. The Fed is widely expected to raise its benchmark federal funds rate by another quarter percentage point to 5.25 per cent at its June 28-29 meeting.
It would mark the 17th consecutive rate hike over two years — a period in which the Fed has pushed up the funds rate from 1 to 5 per cent. And many economists now believe Mr. Bernanke will be arm-twisting his Fed colleagues to ratchet up rates again when they meet on Aug. 8.
Among Mr. Guynn's liabilities is that he firmly opposed inflation targets — one of Mr. Bernanke's “core policy beliefs,” argued economist Daniel Jester of Economy.com in West Chester, Pa. (Mr. Bernanke has talked repeatedly about a 1 to 2 per cent “comfort zone” for the core consumer price index — the key inflation-tracking measure that excludes volatile food and energy prices). Mr. Guynn is also a well-known “dove” on the committee, and over the years has preferred to err on the side of too much monetary juice, rather than too little.
Mr. Olson, on the other hand, has been a virtual ghost at the Fed since U.S. President George W. Bush appointed him a governor in 2001.
His sin may be that he wasn't enough of an advocate for a tough anti-inflation stance.
“This is just more housecleaning with a new Fed chairman,” economist Benjamin Reitzes of BMO Capital Markets concluded in a recent note to clients.
The dilemma for Mr. Bernanke is the nature of the inflation threat facing the potent U.S. economy. The CPI has been creeping up, even as sectors of the economy are slowing, putting global economic expansion at risk. For example, the jobless rate may be low by historical standards, but there's anecdotal evidence of labour market weakness, including falling hiring announcements and intentions.
Even more troubling is the housing market. Higher rates risk tipping the already-slumping sector into a collapse. Mortgage rates hit a new four-year high last week on the expectation of more Fed hikes. Housing starts are down 20 per cent from last year and builder confidence is at its lowest ebb in 11 years.
Some worry that the higher rates may be unequally hitting the economy's weakest spots, while doing little to attack the main sources of inflation — higher energy and commodity prices plus rising rents.
Many analysts are already making unflattering suppositions about what Alan Greenspan, Mr. Bernanke's predecessor, might have done in the face of similar challenges. Economist David Rosenberg of Merrill Lynch & Co. in New York pointed out that the Greenspan Fed wasn't afraid to stop tightening when the economy showed “visible signs” of slowing.
“The Bernanke Fed, it seems, is a little more rigid in its definition of price stability,” Mr. Rosenberg said. “It has convinced the markets that core inflation, even fractionally above 2 per cent . . . is unacceptable and won't be tolerated.”
And so, while this week's Fed rate hike may be a done deal, Mr. Bernanke and his colleagues will be debating about what to do in August and throughout the fall. Mr. Rosenberg has already put the odds of a recession next year at 40 per cent.
“The risk of a policy misstep is real,” he said.
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