Politics & Policy

Which Greenspan Will Bernanke Be?

Some important questions for the heir apparent.

In testimony last week before the Joint Economic Committee, Federal Reserve chairman Alan Greenspan said the addition of over 100 million educated workers to the global workforce from the former Soviet Union, China, and India would “double the overall supply of labor,” and that this growth in the number of workers will help “to contain inflation” in the future.

While Greenspan has defined inflation in monetary terms in the past, and as recently as 1994 stated as much in congressional testimony, he has in more recent years explained inflation in demand terms, whereby it supposedly results from too much economic growth and/or too few workers. The monetary/demand distinction is important given that Greenspan cited the latter as the reason why the Fed raised rates in 1999. The 1994 Greenspan Fed arguably would not have raised rates in 1999 due to the rising value of the dollar versus commodities and other currencies.

Moving to future Fed policy, past speeches show that like most economists, incoming Fed chairman Ben Bernanke to some degree shares the view that inflation is a monetary phenomenon caused by excess money creation relative to demand. We know this because, in contemplating whether or not the U.S. might hit a deflationary patch in the early part of this decade, Bernanke alluded to the Fed’s ability to use open-market operations to reverse any deflationary occurrence.

Despite this conventional view, Bernanke has on more than one occasion described inflation and deflation in demand terms exclusive of money. His thoughts in this area are crucial given the classical view that demand-driven price spikes are not inflationary and are instead indications of scarcity. Conversely, falling prices due to lack of demand aren’t deflationary; instead they are indications of excess supply. If the Bernanke Fed defines inflation and deflation in demand terms — and worse, responds to this way of thinking — it will by definition distort the price signals that markets use to root out both scarcity and glut.

Bernanke has also written of employment falling below a natural rate, such that inflation is the result. Similar to the above example, for the Fed to act here would distort the process by which the labor force expands and contracts as wages rise and fall. Furthermore, the markets are exceedingly effective in working around real and perceived labor shortages. Economies have wrestled with labor shortages for centuries, and as evidenced by innovations such as the printing press, the tractor, and voice-recognition technology, markets are the best solution to scarce labor.

Most important, inflation has traditionally occurred alongside economic weakness. The evidence from past economic booms is that they have occurred exclusive of inflation. If the economy takes off in future years such that GDP rises and unemployment falls, will the new Fed raise rates with inflationary pressures in mind? The consensus is that it will not, though past speeches and editorials by Bernanke raise important questions.

During the press conference at which his nomination was announced, Ben Bernanke made clear that he would seek to maintain continuity by following the policies pursued by Alan Greenspan. But which Greenspan? While many questions will be asked at Bernanke’s confirmation hearings, arguably the most important will be those that touch on inflation and its causes. Bernanke’s answers will offer useful insight into how his Fed will address economic growth and contraction in the future.

John Tamny is a writer in Washington, D.C. He can be contacted at jtamny@yahoo.com.


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