Drawing a Bead on Bernanke

What will the Fed chief touch on in his July 18-19 remarks to Congress—and what will legislators grill him about? A preview from Action Economics

by Michael Englund

Since Federal Reserve Chairman Ben Bernanke's last semiannual monetary policy testimony before Congress in February, the economic outlook improved while the inflation outlook didn't, and housing's decline moderated, with the sector's slowdown still not having a significant impact on economic growth. At his July 18-19 testimony, the chairman will likely adhere to the same sober tone on inflation taken in the last Federal Reserve policy statement.

The solid labor market has certainly been a welcome trend since Bernanke's February appearance. Persistent strength in payroll growth, on average, has been the biggest upside surprise for the economy, as the moderation in payroll gains to a 145,000 monthly average, from 189,000 in 2006, reflects little more than the expected correction to last year's outsize gains, with virtually no sign of labor market weakness. The monthly pattern of continued job market tightness has been confirmed by virtually all other labor market indicators.

Beyond job strength, the monthly retail sales, trade deficit, and industrial production reports have helped diminish downside economic risk. On the negative side: Weakness in durable-goods orders in January and February that has yet to be fully mitigated by ensuing gains, and the lean first-quarter GDP growth figure for which the ensuing second-quarter rebound has yet to be confirmed with the advance report.

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The inflation figures have sent a more ambiguous signal, as headline and core (excluding food and energy) figures were stronger than expected in the months just after the Feb. 14 testimony, but have since shown moderating core gains. Yet, the Fed is likely looking at the bigger picture of price indicators, and it is here that the Fed's recent boost in inflation concerns likely sits. The year-over-year core inflation figures as gauged by the monthly CPI reports—we will get the June update on July 18, just prior to the start of day one's testimony—have moderated in recent months toward the Fed's 2% "soft" target.

But, headline inflation has persistently outpaced core inflation, and the headline figures are now running remarkably hot even though the current year-over-year gains benefit from easy comparisons given the sharp commodity price drop-off last August and September. As the Fed staff is well aware, headline year-over-year gains will soar above 4% by November even if food and energy prices remain unchanged from current levels, and the path for the core figures will face associated upward pressure.

This concern is likely driving the Fed's reference in the last FOMC statement that "a sustained moderation in inflation pressures has yet to be convincingly demonstrated. Moreover, the high level of resource utilization has the potential to sustain those pressures."