Former Fed Chairman Bernanke: More Work to Be Done on Inflation and Interest Rates

Investing.com – The former chairman, Ben Bernanke, who led the US central bank and economy through the Great Recession, believes central bankers still have more work to do to bring down inflation.

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Federal advice

He and economist Olivier Blanchard argue in an academic paper released on Tuesday that achieving this inflation target would require slowing an otherwise exceptionally resilient job market.

The duo offer no specific prescriptions for how much unemployment should rise, but they do suggest that it is possible for the current Federal Reserve to orchestrate its way out of this impasse without severely weakening the US economy.

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“Looking ahead, as the labor market continues to stagnate and inflation expectations recede, we conclude that it is unlikely that the Fed will be able to avoid a slowdown in the economy to return inflation to target,” Bernanke and Blanchard wrote.

Since leaving the Fed in 2014, Bernanke has been a senior fellow at the Brookings Institution. Blanchard is a senior fellow at the Peterson Institute for International Economics.

Their paper notes that inflation has since swelled to a 40-year high in the summer of 2022.

However, they point out that the new phase of inflation is now being driven by rising wages. The good news, however, is that such shocks are generally manageable, but they said the Fed needs to continue trying to address the labor market situation where the unemployment rate is 3.4% and there are still about 1.6 open positions for every available worker.

Bernanke and Blanchard say, “Inflation cannot go down with a strong labor market, as labor demand and supply must be brought into better balance.”

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High inflation

However, the paper looks at why headline inflation as measured by the consumer price index rose above 9% last year.

Most economists agree that the combination of trillions in government spending combined with zero interest rates and about $5 trillion in bond purchases from the Fed flooded the economy with money and created distortions that drove up prices.

With inflation rising beyond the Fed’s 2% target, policymakers insisted on calling the trend “temporary” and did nothing but begin to discuss when it would reduce its bond purchases. The Fed only started raising interest rates in March 2022, a full year after its preferred measure of inflation exceeded the target.

Since then, policymakers have raised the benchmark interest rate 10 times for a total of 5 percentage points, pushing the federal funds rate to its highest level in nearly 16 years.

“Error in tactics”

Former Fed Vice Chairman Richard Clarida, who was a member of the FOMC during the inflationary surge, called the Fed’s reluctance to tighten policy “a mistake of tactics rather than strategy” and attributed it to the uncertainty of the economic landscape.

He also noted that the Fed was not alone: ​​many other global central banks have chosen not to raise interest rates amid soaring inflation.