Posted by Joseph Y. Calhoun, III

Ben Bernanke spoke to the Economic Club of New York today. The full text of the speech can be found here, but I’d like to highlight the last two paragraphs:

The outlook for inflation is also subject to a number of crosscurrents. Many factors affect inflation, including slack in resource utilization, inflation expectations, exchange rates, and the prices of oil and other commodities. Although resource slack cannot be measured precisely, it certainly is high, and it is showing through to underlying wage and price trends. Longer-run inflation expectations are stable, having responded relatively little either to downward or upward pressures on inflation; expectations can be early warnings of actual inflation, however, and must be monitored carefully. Commodities prices have risen lately, likely reflecting the pickup in global economic activity, especially in resource-intensive emerging market economies, and the recent depreciation of the dollar. On net, notwithstanding significant crosscurrents, inflation seems likely to remain subdued for some time.

The foreign exchange value of the dollar has moved over a wide range during the past year or so. When financial stresses were most pronounced, a flight to the deepest and most liquid capital markets resulted in a marked increase in the dollar. More recently, as financial market functioning has improved and global economic activity has stabilized, these safe haven flows have abated, and the dollar has accordingly retraced its gains. The Federal Reserve will continue to monitor these developments closely. We are attentive to the implications of changes in the value of the dollar and will continue to formulate policy to guard against risks to our dual mandate to foster both maximum employment and price stability. Our commitment to our dual objectives, together with the underlying strengths of the U.S. economy, will help ensure that the dollar is strong and a source of global financial stability.

Of the four factors listed in the first highlighted sentence that Bernanke believes affect inflation, only two (inflation expectations and exchange rates) have any effect on inflation. Resource utilization refers to the output gap theory of inflation that was proven wrong repeatedly in the 1970s. Even the Fed’s own research shows the output gap is worthless when it comes to predicting inflation. The price of oil and other commodities are symptoms of inflation and therefore cannot cause inflation. On the second sentence, how can Bernanke say that long run inflation expectations are stable when gold hits a new record every day? On the third sentence, why would an increase in economic activity in emerging markets cause a rise in commodity prices? Aren’t emerging markets primarily producers of commodities? Wouldn’t an increase in economic activity in these countries indicate an increased supply of commodities? How exactly would that cause a rise in commodity prices? And finally on the last highlighted sentence, it is the commitment to the dual mandate that is undermining the dollar right now. If the Fed’s mandate was merely to maintain the purchasing power of the dollar - the only thing monetary policy can really accomplish - the dollar would not be falling right now.

When the head of the central bank doesn’t understand what causes inflation is it any wonder that the dollar is falling?