from staff
Federal Reserve Board Chair Ben Bernanke spoke to about 40 students at Jacksonville University on Friday. He explained how the Federal Reserve System was created and operates and then took questions from the students, who came from several institutions. Here are some of the questions and answers, which are edited for length.
University of North Florida Student: You’ve mentioned that the Federal Reserve sees an extended period of low inflation which could spread the economy eventually to deflation. I’ve seen commodity prices since the summer of this year skyrocket. Soft commodities such as cotton, sugar, have nearly doubled since this summer, and it seems like producers are eating most of that price increase. But I think that there is a possibility that it could be trickling down to the consumer next year. So do you see any possibility of higher inflation next year?
You’re absolutely right, that the one exception to the general observation that inflation coming down is that globally traded commodities like energy have been going up pretty sharply, and the reason for that is because supply and demand is determined on the global level and emerging markets are growing quite quickly. The demand for those commodities is pretty strong. So that is going to be a contributor to inflation in the U.S., because of (the) increase in gas prices and so on.
Our research and our experience, though, suggests that where there’s a lot of slack in the economy, and a lot of excess supply, it’s very, very difficult, as you were saying, for producers to push through those costs to the consumer.
In addition, most of the costs that producers have are labor costs, and wages have been growing relatively slowly and production has been growing relatively strongly, which means overall the cost of labor per unit of production in some cases is actually falling.
You put that all together, and you don’t expect to see very much inflation ... being passed through to final goods and services, with a few exceptions like gasoline.
We do believe that inflation is likely to stay quite low going into next year, and although as you say, the Fed is monitoring inflation very carefully, I think it’s going to at least take some growth, some further growth and some reduction in slack before we see any kind of inflation pressure. At that point we’re going to have to be sure to modify the amount of stimulus to maintain stable prices in the long term.
Jacksonville University student: I’m curious how you think the results of the midterm elections will affect fiscal and monetary policy in the next six months.
The Federal Reserve is totally nonpartisan. We work with both parties, we work with the administration and the Congress, so we’re not in the business of making political predictions. Our basic goal is to do what we can to support the economy, to create employment opportunities, to create price stability, and we want to work with Congress, we want to work with the administration, to get as much help, as much good growth, as much growth-enhancing policy as we can for the rest of the government.
Rollins College student: I actually want to know about what you were facing ... when you bailed out AIG (American International Group). You were facing a lot of opposition from your advisers. So I wanted to know what your reasoning was in the bailout, why you went for it, and what your first initial reaction was when you found out they had used $165 million of that bailout to pay their executives.
We took the action, and I don’t know where you get the idea our advisers were against it, they weren’t.
Before I became chairman I was a professor, and one of my major interests was economic history, and I read a lot about the Great Depression, and I take two lessons from the Great Depression. One, is that monetary policy needs to be supportive of the economy. That monetary policy was incredibly tight in the 1930s, which is part of what happened, that was part of the crisis. The other lesson was that broad-based financial crisis is incredibly destructive to the broader economy, and this is a lesson that’s been learned over and over again, not just in the Depression, but in many other contexts. So, it’s extremely important to try to prevent a systemically important large, really interconnected firm from collapsing in the middle of a broad financial panic.
And in the middle of that time, the whole global financial system was under a lot of pressure. So we were doing our very best to prevent a disorderly collapse of a major financial firm. There was no doubt in our minds that we needed to do whatever we could, but unfortunately, the tools were very limited.
I think a very important element in the new Dodd-Frank (Wall Street Reform and Consumer Protection Act) financial regulatory reform, that was done in the summer is ... we’re developing a set of tools that will allow us to take a systemically critical firm into receivership, that’s essentially into bankruptcy, but do it in a way that protects the financial system and doesn’t lead to that kind of situation we were in in 2008.
That’s critically important, but in 2008 we didn’t have any such tools. You know the FDIC’s (Federal Deposit Insurance Corp.) ability to take those receivership banks only applies to banks. It didn’t apply to AIG. It didn’t apply to other nonbank firms. So we really didn’t have good tools.
The only tool we had, which
didn’t work, was to lend money, and as I said earlier, AIG was facing a run. Cash was flowing out as creditors were demanding their money, or counter-parties were demanding their money. So the best way to stop a run is to lend against collateral.
What was interesting about AIG was that this was one of the world’s largest insurance companies, which had attached to it this one relatively small division that was making very dangerous bets in the financial market.
It was that relatively small division that created the losses and the risks that essentially were about to bring down the whole company. So the insurance company itself was an ongoing viable enterprise, and therefore the company itself could become collateral for a loan to prevent the immediate collapse of AIG.
We were certainly not happy about doing it ... but we knew that if that company collapsed, on top of the Lehman (Brothers) collapse the day before, two days before, that very likely the whole financial system would collapse. And then we would have faced a much much worse economic situation.
So in doing that, we didn’t do it to bail out AIG managers or AIG creditors or employees or stockholders, we did it because we knew if we let that company collapse, that the danger to the world economy was enormous. So that’s why we did it. Fortunately AIG is going to get that loan repaid very soon. And we succeeded in avoiding the financial meltdown.
So I think what was in some sense a very unpleasant experience and one that I wish I didn’t have to be involved in, it was really important to do.
You asked about the bonus issue. You know, that was a bad judgment on the part of the management. When I heard about that, I inquired whether there was legal action we could take to stop it. I was told there was not. It was a relatively small amount of money compared to what was being involved, but it was a very bad event in that it created a lot of resentment and anger among the public, which was certainly understandable, so in that respect it was certainly a bad event.
After that happened, as you know, the Treasury began to formalize its management of compensation for not only AIG, but for other companies that received help. So that has not been the Federal Reserve’s problem, thank goodness, for some time.
JU student: How do you think the growth of China will affect policy in the future?
Growth in foreign economies and emerging markets ... has a number of effects. One effect is that it raises market prices ... but another effect is it serves as an engine for growth and demand for the global economy. So having growth in emerging markets is basically a good thing.
The development of China and India and other emerging markets has brought many, many people from abject poverty into a decent living standard, or even in some cases to a middle-class type living standard. So in that respect it’s very positive.
Generally, it’s good for the global economy. The global economy is not a zero-sum game. If another country does well that means we’re worse off – that’s not the case.
... Certainly a stronger, well-functioning Chinese economy is basically good for the United States.
As I said earlier, our focus is in the United States and as Chinese growth affects prices, output, employment, exports and so forth in the United States, then that factors into our analysis, and part of how we make our policy.
UNF student: I was wondering how your view of the Dodd-Frank legislation will affect how the Fed deals with asset bubbles, like the housing bubble and so forth?
There’s a very important philosophical change in our supervisory and regulatory system, which is embodied in the Dodd-Frank legislation. Prior to the Dodd-Frank legislation, individual regulatory agencies focused on just those firms or those markets for which they were directly responsible. So the banking agencies looked at the banks. The Commodity Futures Trading Commission looked at the exchanges. Insurance regulators looked at the insurance companies and so on.
There were a couple of problems with that approach, which became very evident during the crisis. The first is that level of regulation was very uneven. So while some institutions received a lot of oversight, there were some, like AIG and others, that were essentially falling between the cracks and nobody was really watching them very carefully. That was one problem – the gaps.
The second problem is that a financial crisis, particularly one as severe as this one, is a much broader event than, say, the failure of one institution. It involves very complex interactions across a wide variety of markets and institutions.
But there was no way of looking at that phenomenon from a systemwide perspective. So a very important element of Dodd-Frank, besides trying to patch up the gaps in the oversight, is to ... say that part of the responsibility of the Federal Reserve and other agencies is to try to look at the system as a whole. And there are a number of ways in which that’s going to happen.
One of the most basic is that the legislation creates a new council called the Financial Stability Oversight Council, which will have as its membership the major agencies, the Fed, the Treasury, and this council will meet regularly, and try collectively to talk to each other and try to identify if a problem like the housing bubble or some other types of asset price bubbles or other kinds of problems (are) arising.
By comparing notes and getting together and creating a systemwide approach, we should be better able to identify such problems.
Now, of course, we can’t guarantee that we can see everything that’s going to happen. For that reason, it’s also very important that the legislation takes a lot of steps to strengthen the system, so that if it is hit by a shock, it won’t be as fragile as it was in 2008.
It’s really a two-pronged approach ... to look at the system as a whole, to try to identify risks that are emerging across the range of market institutions, and on the other side, we want to do everything we can to strengthen the system so that if there is a shock or a problem, it will be better able to withstand it than it was for the last two years.
UNF student: My question about (your) 2002 speech on inflation, making sure it doesn’t happen here, and you said that Japan’s economy faced significant barriers to growth besides deflation. You mentioned that those included massive financial problems in the banking sector and the large overhang of government debt, which made policymakers reluctant to use aggressive fiscal policies. At that time you felt the U.S. did not share those problems. Do you still feel that way? Why or why not?
I think that Japan has a number of strengths and it’s still a very rich economy. But it has problems as well. I would say that one of the main problems that Japan has is, that we don’t really share, is demographics. Japan is getting older, even more quickly than the U.S., to the extent that its workforce is on the brink of actually shrinking, and that’s bad for its overall growth. It may have adverse effects on its innovation, perhaps, so I think that’s one major problem that Japan has that we don’t have.
Now, on the fiscal side, they still remain sort of a recordholder in terms of the amount of debt to Gross Domestic Product, which is 200 percent, which is offset by some extent by the fact that they are big savers, as well. So they own most of their own debt.
In the U.S., the ratio of debt to GDP is much less than that, and it’s still been rising pretty significantly, and in addition we have obviously some very long-term serious fiscal issues we need to address. Recently I’ve given a couple of speeches and testimonies that address the need that we have, and I think everybody understands, to deal with our long-term fiscal issues in the United States.
We’re not yet to the 200 percent level by any means, but we need to take action to (bring) our long-term fiscal imbalances into better alignment, or it will at some point, lead to some very severe problems.
Rollins College student: As we’ve seen commodity prices rise, especially in gold, it seems ... like a lot of these measures might lead to easing of inflation.
We are absolutely committed to keeping inflation low and stable. ... I explained how we have tools to unwind and tighten policy when that time comes. And we will honor both sides of our dual mandate.
So there’s no question that we will be able to manage that. I think it’s important to understand that as best as we can tell, looking across a variety of indicators, that inflation expectations remain really quite low.
... If you look at surveys of consumers and businesses, you don’t see any increase in inflation expectations. On the contrary, in most cases, you’ve seen stable or slightly lower inflation expectations. And yet another group that we look at, we look at professional forecasters who try to use the best information they have to predict inflation over long periods of time. And that’s also been very stable, so inflation expectations are pretty stable in the U.S., and that’s a good thing, because it protects in both directions.
Inflation expectations ... protect against higher inflation, but they also protect against disinflation, or declining inflation.
So it’s very important for the Fed to keep inflation expectations well anchored and stable. I think they are stable, and we’re going to continue to work to keep them there.
JU student: My question is in regard to the housing market. What kind of timeline do you think the United States is looking at in order for the housing market to recover so that property owners can start to see some appreciation in their property, where it’s lost value?
The first thing we can say is that the amount of residential construction in the United States today is below what has to be the longer-term normal. Because right now, construction is basically lower than almost any time since World War II, even during periods when the population was much less than it is today. So we have a growing population, we have new households being formed. At some point housing construction’s got to be higher than it is today, and you can expect at that time to see house prices normalize in one way or another.
The problem is that we still have some steps to go before we get there. One basic problem is that we still have a lot of foreclosures in process, and that takes time. It takes time for the market to adjust to that, when you have a lot of foreclosed homes on the market, that pushes down prices and makes it more difficult for new construction to be marketed, so we do have some important problems ... before we can get out of the current problems in the housing market, but eventually we will. We have to, because our population is growing, both from natural increases and immigration, and we will need places for people to be housed.