Many expected US
Fed Chairman Ben Bernanke’s speech
to the Economic Club of Chicago
to be decidedly hawkish given his recent strong anti-inflation comments, but he
surprised by playing down the threat of inflation, saying that inflationary
expectations “remained within the ranges in which they have fluctuated in recent
years and inflation compensation implied by yields on government debt has fallen
back somewhat in the past month”.

Bernanke focussed
on the differentiation between “first-round” and “second-round” effects of
rising energy prices on inflation. First-round effects are those directly
related to the rising energy costs, such as higher costs of production for
business. The second-round is the indirect effects of higher energy prices,
such as worker demand for higher wages after a pay increase.

According to
Bernanke, since 1980 when the Fed employed policy intent on reducing
inflationary expectations, the second-round effects have been severely
diminished. Bernanke also said rising energy prices were largely responsible
for the recent uptick in inflation, and reduced expectations of inflation mean
“firms have both less incentive and less ability to pass on increased energy
costs in the form of higher prices, and likewise workers have less incentive to
demand compensating increases in their nominal

He went on: “in
the long run, market forces will respond [to rising energy prices]. The higher
relative prices of energy will create incentives for businesses to create new,
energy-saving technologies and for energy consumers to adopt them. The market
for alternative fuels is growing rapidly and will help to shift consumption away
from petroleum-based fuels.”

Not wanting to
appear too doveish, Bernanke chose his words carefully – “Nevertheless, these
[inflationary] developments bear watching.” After a hawkish
speech two weeks ago, the markets were relieved that Bernanke is not solely
intent on reducing inflation at the expense of economic

Henry added: “Huge
relief rally followed and US equities were up 2% (more for the Nasdaq).
Resource prices rose and resources roared. Australia will be celebrating today
and Asian markets will continue yesterday’s

Henry Thornton.

Peter Fray

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