SLACK LABOR MARKETS WILL HOLD DOWN PRICES / THE WALL STREET JOURNAL OP EDITORIAL

Ben Bernanke vs. The Journal on Inflation

Slack Labor Markets Will Hold Down Prices

Don't worry about commodities or the exchange value of the dollar ?

Editor's note: The Federal Reserve recently released the transcripts of the 2003 meetings of its Federal Open Market Committee, which determines monetary policy. The following are the remarks at the Dec. 9, 2003 meeting by Ben Bernanke, then a Fed governor who succeeded Alan Greenspan as chairman in 2006. A related editorial appears nearby.

Thank you, Mr. Chairman. The economic news since our last meeting has been heartening. The odds that we have begun a strong and sustainable expansion have risen significantly. Because of the rise in growth, we're going to see even more op-ed articles, wire stories, and editorials opining that the Fed needs to tighten soon to avoid a repeat of 1980s-style inflation. The Wall Street Journal today has an editorial along those lines.

I believe these critics are not particularly well informed and that, as a Committee, we should continue to remain patient and not choke off growth unnecessarily. In particular, though of course we have to be vigilant to detect any change in the inflation trend, the odds of inflation rising significantly any time soon from its current very low level seem small.

Let me make a few points. First, those on the Street and elsewhere who lately have been worrying about inflation have tended to point primarily to raw materials prices, which have been rising, and to the dollar, which has been falling. Here I will largely reiterate some things that [Fed staffer] Dave Stockton said. The Board staff's Monday briefing, which I believe has been posted electronically, debunked the importance of the raw materials argument quite convincingly in my view.

The briefing includes a graph of the historical data, which shows that even very large movements of raw materials prices -- which are quite common by the way -- appear to have muted effects on intermediate goods prices and, most important, no discernible effects at all on final goods inflation. Presumably this lack of inflationary impact reflects the fact that raw materials are only a small part of total costs. As another figure in the briefing showed, unit labor costs -- which, of course, have been falling rapidly as productivity has surged and wage growth has slowed -- are far more important in inflation determination than are materials prices.

An analysis similar to that for raw materials would apply to the dollar. As we've been seeing, large movements of the dollar against major currencies tend to translate into smaller movements against the U.S. trade-weighted basket of currencies and into still smaller effects on import prices because of imperfect pass-throughs. Nonoil import prices, in turn, are a relatively modest part of the overall price index. In short, the ultimate effect of the dollar depreciation of the magnitude we have seen on broad measures of core inflation is likely to be quite small indeed.

I noted the key role of unit labor costs in inflation. Of course, unit labor costs will not continue to fall at the recent rate. Indeed, as employment picks up, productivity growth in particular will slow markedly. Critics may point to this decline in productivity growth as another incipient source of inflationary pressure.

I would just note that this prospective productivity decline is fully incorporated in the Greenbook forecast....

Finally, although output gaps are of course very hard to measure, the weight of the evidence continues to support those who believe that considerable slack remains in the economy. Let me give one bit of evidence on this point. The recent New York Times article by Chicago economist Austan Goolsbee argued that the rise in the unemployment rate in the past two years understates the degree of labor market weakness.
The reason is that today a large percentage of job losers, a greater fraction than in the past, simply withdraw from the labor force, for example, to apply for Social Security disability benefits. I looked at data on the ratio of employment to the working age population, which combine information on both unemployment and labor force participation and found that they confirm this general observation.

Between its peak in April 2000 and its trough this past September, the employment-to-population ratio fell 2.8 percentage points. With the strong gains in the household survey of the past two months, the net decline in the employment-to-population ratio since 2000 is still 2.4 percentage points. For comparison, the combination of the 1980 and 1981-82 recessions, during which the unemployment rate peaked near 11%, produced a peak-to-trough move in this ratio between September 1979 and February 1983 of 3.0 percentage points. The decline attributed to the 1981-82 recession alone from its local peak in April '81 until February '83 was 2.5 percentage points. So on this particular metric -- and of course it's only one metric -- the deterioration of the labor market from 2000 until now is comparable to what occurred during the deep 1981-82 recession. For comparison, the movement in the employment-to-population ratio from its peak to its trough during the 1990-91 recession period was 2.0 percentage points.

Possibly the extent of the recent decline is exaggerated because employment was unsustainably high in 1999 and 2000. However, even relative to a more neutral benchmark of 5% unemployment and a participation rate at its long-run trend, current household employment -- the more optimistic of the surveys -- remains some 2.9 million jobs below normal. That number fully incorporates the rise in self-employment about which much has been made. On balance, the large decline in the share of the population that is working suggests that employment can rise significantly before we see pressure on wages and unit labor costs.

To summarize, vigilance on inflation is absolutely essential. I do not disagree with that one bit. But we should not overreact to purported signs of inflation that are in reality no such thing. Thank you.

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