Fed Chairman Ben BernankeWin McNamee
With a key measure of U.S. inflation falling to its lowest level on record, Federal Reserve Board chairman Ben Bernanke may silence some critics who warn of a dangerous upward pressure on prices stemming from his renewed effort to pump liquidity into the financial system.
Core inflation, which excludes volatile energy and food prices, fell to an annual rate of 0.6 per cent in October, setting its lowest year-over-year pace since the U.S. government began measuring the rate in 1957.
The Labour Department report appeared to vindicate the Fed's Nov. 3 move to launch into another round of quantitative easing with plans to buy $600-billion (U.S.) of Treasury securities over the next eight months. The aim is to drive down longer-term interest rates to spur consumer and business borrowing.
The persistence of weak economic growth and high unemployment since the U.S. central bank ended its previous bond-buying program in March has caused overall inflation to fall below the Fed's informal target of between 1.5 and 2 per cent on an annual basis. It was 1.2 per cent in October, though much of the increase resulted from a spike in gasoline prices.
The 0.6-per-cent core rate suggests the U.S. economy may have fallen into a period of disinflation, with consumer prices rising more slowly with each successive month. Without more action by the Fed, the risk of deflation taking hold could have grown more pronounced, undermining consumer and business confidence in spending and investment.
Still, while a majority of analysts appear to support the Fed's decision to start another round of quantitative easing - dubbed QE2 - the central bank is facing an onslaught of criticism from all sides.
Conservative economists and Republicans in Congress are become more strident in publicly bashing the Fed, warning that it could be planting the seeds for runaway inflation later. They note that since the Fed began hinting in late summer that it would take more stimulative measures, the U.S. dollar has dropped by more than 10 per cent, while gold and commodity prices have risen by double digits.
Even analysts who play down the inflationary threat question how useful QE2 will be in prodding banks into lending. U.S. financial institutions are still sitting on a mountain of delinquent mortgages, making them skittish about extending or renegotiating home loans in this environment.
"It seems perspective has gotten a little bit lost with talk of QE2 leading to hyperinflation," said Toronto-Dominion Bank senior economist James Marple. "But there are absolute limits to how successful this can be … As long as credit growth is restrained, you're going to see monetary policy be pretty ineffective."
The Fed has come under assault not only by domestic critics. China and Germany, among other countries, have accused Washington of pursuing a "weak dollar" policy to give U.S. exports an advantage. But Mr. Marple suggested the dollar, which has risen in recent days, may be headed further upward in coming weeks as Europe's debt woes drive investors to the greenback.
University of Oregon economist Mark Thoma, who writes The Economist's View blog, is among those who think the Fed is being too timid in its approach.
"People still aren't looking to a very rosy future and I don't see how lowering interest rates by less than 1 per cent is going to change people's incentives [to borrow]very much," Prof. Thoma said in an interview. "From the Fed's perspective, I don't think they're doing enough quantitative easing fast enough."
Still, with the Fed's every step stoking controversy in Washington and on Wall Street alike, Mr. Bernanke may be forced to tread cautiously even if its latest effort to prime the pump fall short of its goals.
James Grant, editor of the influential Grant's Interest Rate Observer, admonished the Fed in a Sunday New York Times opinion piece that the price to pay for its accommodative monetary policy could be devastating.
"A partial list of unwanted possibilities include an overvalued stock market (followed by a crash), a collapsing dollar, an unscripted surge in consumer prices (followed by higher interest rates), a populist revolt against zero per cent savings rates," Mr. Grant wrote. "As for interest rates, they are already low enough to coax another cycle of imprudent lending and borrowing."
For a central bank that failed to anticipate the last financial crisis, persuading some in the market and on Capitol Hill that it is prescient enough to prevent the next one has become a tougher case to make.
Konrad Yakabuski