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Bernanke-Hawk or Black Hawk?

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06/06/2006

Before he became Fed Chairman, Ben Bernanke became infamous as a crazy inflationist willing to go as far as dropping dollar bills from a helicopter if necessary to safeguard the existence of price inflation, earning him nick names like Ben "Printing Press" Bernanke, Ben "Helicopter" Bernanke and Ben "Black Hawk" Bernanke. This was troublesome for Bernanke, because a reputation as a inflationist is -whether fair or not- not good for any central banker. In order to make maximum gains from its money creation, the public must not expect the price inflation it will create. If it is anticipated by the public, then the redistributional effects the Fed hopes to achieve will be small, while demand (and therefore central bank gains) for the newly created currency will be lower.

So, it is in the best interest of central banks to lower inflation expectations even while it is also in the best interest of central banks to maximize monetary inflation. These two interest are of course incompatible, which is why central banks must try to balance these two aims. When inflationary expectations are rising, as they are now, then the central bank will have to give priority to containing them, rather than its other aim of maximizing actual inflating of the money supply.

Given his reputation as an inflationist, and given that even so-called core inflation is rising now in America and given that commodity prices are soaring and that various indicators of inflationary expectations (including the spread between regular bonds and the TIPS) are rising, Bernanke now have little choice but to continue with the rate hikes, even knowing this risks sending the U.S. economy into a recession.

We should therefore not see the latest seemingly "hawkish" speech from Bernanke that have caused stock prices to tumble as an indication that Bernanke is really a inflation hawk. Instead, he is simply trying to do away with his reputation as a "Black Hawk" riding inflationist. Unlike some other "Black Helicopter" conspiracy theories, the one about the Fed being a inflation creator is really true (although at this point not by the actual physical mean of black helicopters).

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