Wednesday, July 19, 2006

Bernanke's Testimony

Some quick thoughts on Ben Bernanke’s testimony today:

The best thing I saw was his reference to a very healthy and sound business sector with high productivity, strong profits, plenty of cash, and a strong backlog of new durable goods orders, which suggests big capex spending in the future.

The testimony itself was fairly bland. It's an economic forecast-driven Fed outlook, based on the Fed's own models, that apparently show a sizable decline for economic growth in the second-half of this year, along with a moderating core inflation rate. Implicit in the forecast is about a 2.5 percent second-half growth rate that I think is too low. So, if Bernanke is operating policy through the economic growth rate, there will be one or two more tightenings this year. On inflation he could be right.

Bernanke's testimony was definitely not a supply-side approach to economics. He did mention a TIP-based forward indicator of inflation, but there's really no clear liquidity model that relies on sensitive market price indicators like gold, commodities, and the dollar. I do like the TIP model reference, which looks to me about 25 basis points too wide. I definitely favor a 5.5 percent fed funds rate target.

I was disappointed that Bernanke made no mention of the dollar. Nor did he mention lower tax rates on private investment as a spur to economic growth. Because of low tax rates, I continue to believe the economy will surprise on the upside in the month's ahead. That is why I think the Fed will feel compelled to raise rates a bit more. That being said, an investment-led expansion is counter-inflationary, as supply drives demand and more goods are available to absorb the existing money stock. Low tax rates are similarly counter-inflationary.

But this is a data-driven approach to Fed policy. Looking through the rear-view mirror, I preferred Alan Greenspan's seat of the pants approach, which left room for more scrutiny of market-based indicators of both inflation and growth.

All of this leaves me still nonplussed about our new chairman, who is very much a state of the art economic scientist. I just don't think scientific models are nearly as accurate as market-based price watching.