Relevance of My Interaction with Ben Bernanke, Former Chairman, the US Federal Reserves in Explaining the Current US and Global Inflation
By VK Sharma, Former Executive Director, Reserve Bank of India
The current 40-year high US and global inflation ( 9.1% in the USA and UK and 8% in Germany ) took me more than 9 years back in time to my interaction with Mr Ben Bernanke in December 2012. In the course of my above interaction , my substantive question to Bernanke was on the inflationary potential of the near-zero policy rate alongside QEs ( Quantitative Easing ) given that a number of leading economists, including Nobel Laureate Edmund Phelps , held that post-crisis the US NAIRU ( Non Accelerating Inflation Rate of Unemployment ) , which corresponds to full employment , had moved up and was more like 7.5 % and , therefore, exactly like the Arthur Burns Fed during the 1970s , the Bernanke Fed may be at full employment at near-zero interest rate with huge monetary stimulus and not realize it ! ( Actual unemployment rate lower than NAIRU is inflationary and , therefore, wider this gap , higher the inflation ) . The Arthur Burns Fed thought NAIRU was about 4 % and it loosened policy only to land the US into massive double digit inflation which forced the Volcker Fed to raise interest rate to 20 % at huge cost to the US and the world economy ! In fact, when bidding farewell at Fed in 1979, Burns acknowledged that he made a mistake, not realizing that the NAIRU was more like 6 %+ rather than 4% he assumed !
Not directly answering my question by avoiding his own take on the then prevailing NAIRU, Bernanke said the Fed's stance was a judgement call.
In support of my question , I referred to other evidence to say that monetary transmission was almost dysfunctional what with banks keeping excess reserves of $ 1.5 tn + with Fed rather than on lend to small businesses and households and large businesses sitting on a cash pile of $ 2 tn and not investing and asset bubbles again inflating like during pre-crisis period including in US treasuries where TIPs ( Treasury Inflation-Protected Security ) are trading at negative yields of -0.9 % !
I am very happy to say months later, Bernanke took cue from my question and views and made an unorthodox policy announcement that the Fed will continue with its QE until unemployment rate came down to 6.5% without explicitly calling it NAIRU and keeping it 1% point lower than what I had mentioned during my interaction, i.e 7.5% !
And , lo and behold , in the USA , the current NAIRU is 5% and actual unemployment rate is lower at 3.6% ! Though I couldn’t get the current NAIRU statistics for the UK and Germany , the current 40-year high inflation rates mentioned above incontrovertibly suggest that, as in the USA , there also NAIRU must be higher than the actual lower unemployment rates and hence the 40-year high inflation !
Since NAIRU is a significant explanatory variable - though not the only one - of accelerating inflation , the foregoing analysis should be reason enough for the RBI to start working with Government for building a credible and robust unemployment database and start using , inter alia , NAIRU statistic in making monetary policy .
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