Ben Bernanke is a university professor as well as a central banker. A speech on Monday reflected both roles. The part coming from the former chairman of Princeton University’s department of economics was more alarming than that from the current chairman of the US Federal Reserve.
The markets only studied the Fed-speak. Bernanke downplayed the risk of a “substantial economic downturn”, expressed no urgent concerns about financial stability, and said the Fed will “strongly resist” any “erosion” of longer-term inflation expectations.
But the academic discussion was more revealing. It showed Bernanke is deeply puzzled by the dynamics of inflation.
Commodity prices were the first topic. These are excluded from the Fed’s preferred measure of “core” inflation. But Bernanke admitted that this policy has led to “underpredictions” of inflation. He also expressed bafflement as to why so many disparate commodity prices have risen so far so fast.
He then turned to the relationship between prices and wages. There is a fog of data, but it seems employers don’t hold wages down the way models say they should. It matters because the models predict that a weak economy will keep wages from rising to match higher prices.
The final topic was how inflation expectations work. There the intellectual quandary seems almost complete. No one knows how these expectations are set, why they change, or how they actually influence the setting of wages and prices.
Professors like lively debates, so perhaps Bernanke’s admissions of ignorance shouldn’t be interpreted as a cry of intellectual despair. But with the persistence of global inflation surprising most economists, the conventional model could do with a few fundamental challenges. Perhaps Bernanke should think more about money and credit. The old explanation of inflation didn’t involve expectations and squeezes on capacity, but an excess of spending power over the supply of goods and services. That monetarist theory could be due for a big revival.