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Former Federal Reserve Chairman Bernanke: Further efforts are needed to reduce inflation, and the impact of the labor market is now greater

Release Time:2023-05-24
Former Federal Reserve Chairman Bernanke, who led the Federal Reserve through the 2008 financial crisis, believes that Federal Reserve officials need to do more to curb high inflation.

In an academic paper published on Tuesday, May 23, Eastern Time, Bernanke and former IMF Chief Economist Olivier Blanchard, who co authored the paper, pointed out that efforts to curb inflation need to slow down the consistently resilient US labor market.

Bernanke and Blanchard did not suggest in the article to what extent the unemployment rate needs to rise in order to curb inflation, but hinted that the Federal Reserve may emerge from the predicament without seriously damaging the US economy.

The article wrote that the estimation model used by the two people deconstructed the different sources of inflation during the COVID-19 epidemic, broken down into the impact of different shocks, and deconstructed the general equilibrium theory effect, hysteresis and connection between the inflation sources acting through inflation expectations and other channels.

The two believe that the rise in inflation that began in 2021 was initially mainly driven by the energy market and the shortage of durable goods such as cars, but over time, the tight supply in the labor market began to have a greater impact on the upward trend of inflation.

The conclusion of the two is:

"In the early days, the tension in the labor market had a moderate impact on inflation, which could explain why inflation might rise significantly when the Phillips curve of wages was flat. Most of the early inflation came from the commodity market, including the price of bulk commodities and the price rise of industries with limited supply.

As commodity prices stabilize and supply chains return to normal, the importance of commodity markets in inflation may decline, and the impact of the labor market becomes more prominent.

Looking ahead, due to the relaxation of the labor market (i.e. the degree of oversupply weakness) still below sustainable levels, and the mild rise in inflation expectations, we conclude that the Federal Reserve cannot avoid slowing down the economy (growth) if it wants inflation to return to its target level. “

Bernanke and Blanchard believe that after reaching a four-year high last summer, the inflation situation in the United States has changed. Initially, the price increase was due to US consumers using fiscal and monetary stimulus during the government's pandemic to shift their spending on services towards spending on goods, and the supply deadlock exacerbated inflation.

Now, inflation has entered a new stage, driven by wage increases that are catching up with price increases. Fortunately, the salary conflict is generally controllable. Bernanke and Blanchard believe that the Federal Reserve needs to address labor market issues. On the one hand, the unemployment rate is at a half century low of 3.4%, and on the other hand, the ratio of jobs to vacancies is still about 1:1.6.

The article believes that the impact of the labor market on inflation may continue to increase and will not subside on its own.

The inflationary boost caused by the overheating of the labor market can only be reversed through policy actions. Policies need to achieve a better balance between supply and demand of labor. The balance of the labor market should ultimately be the main focus of the central bank to maintain price stability

At present, some economists and policymakers of the Federal Reserve believe that inflation may be approaching a steady decline, and high inflation only depends on the government stimulus to household and enterprise spending during the COVID-19 epidemic. For example, Chicago Fed Chairman Austan Goolsbee stated that salary increases have little impact on future price increases and largely reflect past price increases.

Wall Street has noticed that during a central bank research seminar with Bernanke last Friday, the current Federal Reserve Chairman Powell's statement seems to be consistent with Bernanke's position in the aforementioned paper on Tuesday.

Powell said last Friday that there is still a lot of work to be done in reducing inflation, with the unemployment rate in the labor market remaining low, there are still many vacant positions, and salary increases exceeding price increases.

Powell believes that when inflation first surged in the spring of 2021, the relaxation of the labor market was not an important feature of inflation. As the inflation situation changes, the relaxation of the labor market may become an increasingly important factor for future inflation.

Powell reiterated that the price increase in the service industry is the most stubborn, and labor costs in the service industry account for a high proportion of total costs.

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