Ben Bernanke, a Princeton University macroeconomist, was recently appointed to succeed the respected Alan Greenspan as the new Federal Reserve Chairman.
In one of his first actions as the Chairman, Bernanke testified before the Senate Banking Committee, vowing to fight inflation, foster economic growth and create more jobs.
In this semi-annual report, Bernanke stated that inflation has been the cause of the U.S. economy running near-capacity, posing a risk that can only be remedied by continually raising interest rates. Bernanke believes that without the interference of the Fed, the momentum of increased aggregate demand will overshoot the output of the U.S.
The Fed has been steadily increasing borrowing costs from one percent to their current level of 4.5 percent, hiking rates 14 times since the current tightening cycle began. With interest rates now at their highest level since April 2001, Bernanke entered his new position at the Fed with a strong plan: to ensure that the market expects higher rates.
Although Bernanke is entering into an economy that is in a state of steady recovery, he will have to contend with a number of looming quandaries, such as the concern of inflation due to stable price growth.
Bernanke, a strong supporter of central bank transparency, believes that the central bank should set a target for inflation and stick to it. This policy, also known as "inflation targeting," is one that has been adopted by many other countries, including Canada, Australia and the European Union. But critics of this approach have labeled Bernanke an inflation hawk, and the policy is also strongly opposed by Greenspan. Bernanke faces a tough job, entering into a difficult economic climate. He and the Fed are experiencing pressure to stop raising interest rates in order to help the U.S. economy recover from Hurricane Katrina. They also have to deal with the possibility of the collapse of the housing market bubble, which would almost certainly have a very strong negative effect on consumer spending.
Although energy prices have been declining, Bernanke seemed certain in his testimony that the tightening economic conditions will push prices higher. The growing trade deficit and large budget deficit also puts increased pressure on the dollar.
In response to the inversion in the U.S. bond market, in which short-term rates grew higher than long-term rates, Bernanke assured the Senate Banking Committee that this did not signal an economic slowdown, as inverted yield curves have in the past.
Indeed, despite these issues, Bernanke forecasted the expansion of the economy by about 3.5 percent this year, and by between three percent and 3.5 percent in 2007.
Further tightening does need to occur, but Bernanke is entering into a tricky market. On the one hand, at the start of 2006, January experienced a blowout retail sales report, with a sales surge of 2.3 percent. This data, in turn, helped the Dow Industrial Index jump 1.3 percent with renewed optimism about consumer spending.
In addition to consumer spending, the Dow experienced a huge gain past 11,000, due to a continued decline in oil prices, which are down 15 percent since hitting their high in August. This strong sign of economic vigor caused traders to upgrade their view of the economy and instilled more investor confidence in Bernanke and the market.
Bernanke said that the Fed will monitor the market and create monetary policy based on incoming data, making conditional judgments concerning both inflation and growth.
