As I urged below, I think the most important part of Ben Bernanke’s speech today is what it does to shape expectations. The news isn’t good. Ben Bernanke is telling people not only that the Fed won’t offer any new stimulus to demand, but that if a demand surge happens through some other means, he’s likely to step in to strangle the economy:
Consequently, although we expect a moderate recovery to continue and indeed to strengthen over time, the Committee has marked down its outlook for the likely pace of growth over coming quarters. With commodity prices and other import prices moderating and with longer-term inflation expectations remaining stable, we expect inflation to settle, over coming quarters, at levels at or below the rate of 2 percent, or a bit less, that most Committee participants view as being consistent with our dual mandate.
In light of its current outlook, the Committee recently decided to provide more specific forward guidance about its expectations for the future path of the federal funds rate. In particular, in the statement following our meeting earlier this month, we indicated that economic conditions — including low rates of resource utilization and a subdued outlook for inflation over the medium run — are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013. That is, in what the Committee judges to be the most likely scenarios for resource utilization and inflation in the medium term, the target for the federal funds rate would be held at its current low levels for at least two more years.
I read those passages as containing several pieces of information. One is that the Fed is targeting an inflation rate of “a bit less” than 2 percent. The second is that this is an asymmetrical target. He expects inflation to settle either at the target level, or else below it, and seems okay with those things. The third is that the “at least through mid-2013” is not a promise to keep rates low come what may. It’s a prediction that holding rates that low “at least through mid-2013” will be consistent with the goal of maintaining an inflation rate “at or below” the target level of “a bit less” than 2 percent inflation. This means that if some surprise new surge in demand comes from someplace else — say a massive Chinese currency revaluation or the population of India developing a huge new desire to buy American soybeans — such that his prediction proves mistaken, the Fed is likely to respond by raising rates. There will be no substantial toleration of above 2 percent inflation.
It’s important to distinguish this from the claim that the Fed can’t do more. They can. As Bernanke says, “The Federal Reserve has a range of tools that could be used to provide additional monetary stimulus.” If he proves wrong on the downside and the economy risks slipping into deflation, he’ll pull the trigger on those tools. But he regards 9 percent unemployment and inflation “at or below” a level “a bit less” than 2 percent as a desirable outcome. He would of course welcome more rapid economic growth, but he’ll tolerate it if and only if it comes from supply-side reforms. Reappointing this guy should go down as President Obama’s biggest error.