E.J.'s Rorschach Test

Speaking before the Senate Banking Committee, Fed Chair nominee Ben Bernanke expressed confidence in the economy while pledging political independence in monetary policy decision making. For a continuation of the mainstream financial media take on yesterday's hearing, go see Bloomberg or Reuters - we're skipping right to the Q & A.

Senator Paul Sarbanes: E.J. Dionne wrote just a few weeks ago, "A Fed Chairman who beats inflation at the cost of middle-income living standards will not be regarded as a success".

What do you think about that observation?

Ben Bernanke: Senator, I think it's a false dichotomy. I think that middle-income living standards, and poverty for that matter, are best addressed through strong stable employment growth. It's low-income people who suffer from recessions. It's low-income people who suffer most from high levels of inflation.

The understanding that central banks currently have is that by maintaining inflation at a low and stable level, avoiding a situation where inflation gets out of control as it did, for example, in the 1970s, you can create more stable, more solid, more substantial growth in employment. I'm entirely in favor of maximum employment. I believe this is a method to achieve it - if I did not think it was, I would not pursue it.

What Senator Sarbanes was referring to was this article from Washington Post columnist E.J. Dionne, which offers this devilishly clever concluding paragraph:

This nomination ought to spur a broad debate on the future of the economy and globalization that pays attention not just to what "the markets" are thinking but also to what is happening to Americans who do not find themselves at the top of the heap. A Fed Chairman who beats inflation at the cost of middle-income living standards will not be regarded as a success.

While obviously a truism, what does this statement really mean?

Not inflation and unemployment, but inflation and living standards?

Has E.J. penned an economics Rorschach Test?

Some time after breaking away from the Senate hearing, Vince Boberski of RBC Dain Rauscher commented on inflation and unemployment:

Something interesting that Sarbanes did touch on, which I think is true, is it's really a little bit disingenuous to say that you'll have an inflation target and that you'll still be able to maintain the dual mandate (price stability and full employment) of the Federal Reserve.
[...]
So, you can talk about it being short term or long term, but clearly the Fed is moving more toward price stability more than the other mandate. It's really supposed to be an equal mandate.

When asked to comment on the Dionne question and the Fed Chair nominee's response, Boberski fawned:

Actually Bernanke had a really good answer to that, but it's not really a trade-off. Short run, I think that it's difficult to argue that there's not really a trade-off between inflation and unemployment, aside from what we've seen in the nineties with the big increase in productivity. But, long run, it's really not a choice.

So, the economists (Bernanke and Boberski) heard a question about inflation and living standards, then proceeded to answer a question about inflation and unemployment.

This is where Main Street and Wall Street seem to part company on contemporary economic thought, and this is perhaps the crux of the modern economist's problem, as viewed by ordinary Americans. When looking at the Dionne statement either by itself, or in the context of the entire article, it is clear that it had less to do with employment than with the quality of employment, meager income growth, and the purchasing power of said income.

In many ways it seems that, to economists, people are just statistics that answer the phone once a month when queried as part of the Bureau of Labor Statistics employment survey. As evidenced by numerous stories about rising energy and health care costs, these are the people whose living standards are in jeopardy, but the economists do not see it.

Rick Santelli offered this unsolicited commentary a few minutes later:

The one topic down here was quite interesting - continued talk down here about how there's a disconnect kind of between Wall Street and Main Street - our guest kind of made fun of the comment that breaking the back of inflation on the middle class doesn't seem to make a star of whoever does that.

Down here, people really identified with that - a lot of the economists I talked to dismissed it.

Maybe that encapsulates the whole scenario.

It's not clear what exactly Rick Santelli and the boys on the floor of the Chicago Board of Trade were talking about, but it likely had something to do with the modern economist's view of the modern standard of living for today's middle-income worker.

On Trade Deficits

In this exchange you can see the striking difference between the incoming and outgoing Fed Chairs. When asked three consecutive times whether he was alarmed about the trade deficit, Bernanke ultimately provides a non-answer (which, of course is the correct response - answering either "yes" or "no" would have been bad, even if you do believe in a "savings glut" theory).

In the same situation, Alan Greenspan would have launched into a long and entertaining discussion, utlimately yielding the same non-answer, but leaving the listener impressed and satisfied.

Senator Chris Dodd: Are you concerned at all about the record levels of debt being held by foreign creditors - we're now talking about numbers that are close to a trillion dollars. Does that worry you at all as a potential chairman of the Federal Reserve?

Bernanke: Senator, given that we have a large current account deficit, which is a complex issue that I'm sure I'll be asked to address and I'll be glad to address, given that the deficit needs to be financed, we are fortunate that foreigners seem quite willing to hold U.S. Treasury debt and other financial instruments, including foreign central banks, so it's like asking how it feels to be very old when you consider the alternative - it's better to have willingness to hold our financial assets than not, given that we have a large current account deficit.

Dodd: But certainly, it would be better if we didn't have to have them hold it at all.

Bernanke: (Long Pause)

Dodd: It's better to be young.

Bernanke: The issue (chuckle) is what to do about the current account deficit, and I would argue that we need, over a period of time, to reduce the current account deficit, and I believe that's a possible thing to do. Once the current account deficit comes down, then the need to have foreign financing will be reduced.

Dodd: You're not alarmed about this at all?

Bernanke: I believe that the current account deficit needs to come down over a period of time.

Dodd: But, you're not alarmed about foreign creditors holding our debt?

Bernanke: I think that it's an essential implication of the fact we have the current account deficit, that it needs to be financed, that we are better off with willing lenders than we are with unwilling lenders - if they were not willing to hold our obligations, interest rates would be higher and the economy would not be as strong.