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Bernanke says risk of 'substantial downturn' in economy has falllen
WASHINGTON (Thomson Financial) - Not only does the 5.5% unemployment rate for May not signal the start of a recession, the risk of one has actually fallen, Federal Reserve Chairman Ben Bernanke contended tonight. 'Indeed, although activity during the current quarter is likely to be weak, the risk that the economy has entered a substantial downturn appears to have diminished over the past month or so,' he said. Despite the 'unwelcome' rise in the unemployment rate reported last week, 'recent incoming data, taken as a whole, have affected the outlook for economic activity only modestly,' Bernanke said in prepared remarks for a Boston Federal Reserve Bank conference on inflation. Over the rest of 2008, the accumulated effects of the fiscal stimulus payments, the Fed's rate cuts, reduced drag from housing, financial market improvement and export demand 'should provide some offset to the headwinds that still face the economy.' That said, housing and energy prices still tilt the economic risks to the downside. The subject of the conference was inflation and on that, Bernanke said the pass-through of high energy and commodity prices to other products and to wages so far 'has been limited, in part because of softening domestic demand.' But there's no guarantee that the pass-through will remain limited and Fed officials are increasingly worried about increasing consumer and business inflation expectations. The latest rise in oil prices has added to the risks that both inflation and expectations will begin to follow i up, Bernanke said. And he declared 'the Federal Open Market Committee (FOMC) will strongly resist an erosion of longer-term inflation expectations.' The FOMC's rate-setting decisions are of necessity made in 'real time,' and Bernanke outlined a number of areas in which the policymakers wish they had better information about inflationary forces as they decide. First comes the question of what exactly is 'inflation.' The numbers come from the Consumer Price Index, the Personal Consumption Expenditure index or other alternatives. Yet each of them 'reflects different coverage, methods of construction and seasonality, and each of which is subject to statistical noise.' Second, fast-rising energy and commodity prices have been the major source of the lasting high inflation numbers in recent years. The Fed has traditionally looked to futures markets for its outlook on where those prices are headed. That's become a problem because 'futures market quotes have underpredicted commodity price increases in recent years, leading to corresponding underpredictions of overall inflation,' Bernanke said. Bernake said there has been 'systematic underprediction of demand and overprediction of productive capacity for a number of commodities, notably oil.' The Fed asked the assembled economists to do more research on how it could better forecast commodity prices and their relationship to inflation measures. Then there is the problem of labor costs. The last great inflation, following the oil price shocks in the 1970s, was a wage-price spiral in which worker demands for higher wages were passed on to consumers as higher prices, resulting in still higher wage demands. The Fed is so worried about inflation expectations because it's so afraid of allowing another spiral to develop. That does not seem to be happening this time. However, both of the government's labor cost measures -- compensation per hour or the employment cost index -- have serious drawbacks and sometime generate conflicting signals. Nor is labor productivity, which has important effects on business costs, measured much better. The wage question is related to inflation expectations, but Bernake isn't sure how closely. 'Is the primary linkage from inflation expectations to wage bargains, or are other channels important?' he asked. Some research shows inflation expectations having little impact on business pricing. And finally, just as with inflation itself, there are measurement problems. There are consumer surveys, economists' forecasts and inflation indexed securities but almost no information from the business people who actually set prices, Bernanke complained. In essence, he told the conference, we at the Fed are doing the best we can with the information we have, but there is a whole lot more we'd like to know. [email][email protected][/email] dem/wash COPYRIGHT Copyright Thomson Financial News Limited 2007. All rights reserved. The copying, republication or redistribution of Thomson Financial News Content, including by framing or similar means, is expressly prohibited without the prior written consent of Thomson Financial News.
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