Bernanke vs Greenspan

Chris Dillow has a nice piece today defending Ben Bernanke's stewardship of the Federal Reserve thus far, responding to his critics, and putting the boot into Greenspan: Lay off Bernanke.  Chris is right to argue that markets had been expecting for some time that the FOMC might pause once official US rates reached 5.0%. The only gaffe by Bernanke so far has been to naively assume that his off-the-record comments to CNBC journalist Maria Bartiromo would not be reported. Hardly a major sin, and I'm sure one he won't repeat in a hurry.

For a different take on the Fed, see Caroline Baum's latest column: The New Fed Chairman Faces the Same Old Dilemma. "How likely is it that, given the first opportunity to put his ideas into practice, he caves and lets inflation accelerate?", she asks.

Federal Reserve Chairman Ben Bernanke is facing that age-old test all central bankers eventually have to confront: what to do in the face of slowing growth and rising inflation. The economic indicators released this week pretty much encapsulate Bernanke's dilemma. Housing is falling fast, and core inflation is accelerating.

...Bernanke isn't dovish on inflation. He has reiterated his view that price stability is both an end in itself and a means to achieve the Fed's other mandate of maximum sustainable growth. He has spent a good part of his academic career documenting the benefits of inflation targeting -- for ne'er-do-well and responsible central banks alike.

...Bernanke's dilemma, in simplest form, is choosing between doing what he thinks is right for the real economy (pausing at the June meeting) and addressing rising inflation expectations in financial markets, driven as they are by the most recent data release (raising rates again).

"If your model of the inflation process gives weight to inflation expectations as an independent force in creating inflation, which the Fed's does, then you have to pay attention to it, no matter what the quality of the data,'' says Neal Soss, chief economist at Credit Suisse Group. Of course, in targeting inflation, a lagging indicator, "you run the risk of making a policy error or chasing the markets rather than leading them,'' Soss says.

Many economists agree that Bernanke has to raise rates in June or risk losing credibility. "If he had been Fed chairman for five years, he could say, to hell with the market,'' and stick with his view, says Ian Shepherdson, chief U.S. economist at High Frequency Economics in Valhalla, New York. "The problem is, he's new, and there's a degree of skepticism about his inflation-fighting credentials."

While options on federal funds futures suggest the market is looking for a pause in June, personally I think it likely that Bernanke will raise the fed funds rate one more time before taking a break, to establish credibility as an inflation fighter. This week's woeful core inflation numbers reinforce that call.