- The Washington Times - Friday, March 3, 2006

Celebrating the 75th anniversary of the Woodrow Wilson School of Public and International Affairs, which is named after the president who was instrumental in establishing the Federal Reserve System in 1913, Ben Bernanke appropriately returned to Princeton University (where he was an economics professor for nearly two decades) to deliver his first speech since becoming Fed chairman. He exceeded the very high expectations.

In his simply titled speech, “The Benefits of Price Stability,” Mr. Bernanke delivered a powerful argument detailing the indispensable role that stable prices and well-anchored inflation expectations play in the modern economy. The role of price stability is straightforward: “Because prices constitute a market economy’s fundamental means of conveying information, the increased noise associated with high inflation erodes the effectiveness of the market system.” Thus, as Mr. Bernanke noted in his Feb. 24 speech, “when prices are stable, both economic growth and stability are likely to be enhanced. And long-term interest rates are likely to be moderate” because low inflation expectations reduce both the risk and the inflation premiums inherent in long-term rates.

The experience from the past quarter century has demonstrated the accuracy of these observations. Only two brief, shallow recessions have punctuated an otherwise relentlessly strong U.S. economic expansion since late 1982. That was the year then-Fed Chairman Paul Volcker succeeded in crushing the intense inflationary pressures prevailing from 1979 through 1981, during which time the consumer price index increased 39 percent. Mr. Bernanke said the “crucial importance of keeping [the public’s] inflation expectations low and stable, which can be done only if inflation itself is low and stable.” During recent years, as the Fed addressed several potentially devastating economic shocks (the bursting of the stock-market bubble, September 11, corporate scandals, soaring oil prices, etc.), Mr. Bernanke pointed to “a virtuous circle” in which “stable inflation expectations help the central bank to keep inflation low even as it retains substantial freedom to respond to disturbances to the broader economy.” Mr. Volcker’s hard-won credibility, which Alan Greenspan enhanced further, allowed the Fed to maintain short-term rates at historically low levels much longer than markets would have permitted in the past.

There is a general consensus today — “the mandated goals of price stability and maximum employment are almost entirely complementary,” in Mr. Bernanke’s words — that was not always so. Indeed, during much of the 1960s and 1970s, price stability and high employment were considered by “some influential voices” to be “substitutes, not complements,” Mr. Bernanke said. As Mr. Bernanke persuasively argued, price stability is a prerequisite to the achievement of the Fed’s other mandated objectives: high employment and moderate long-term interest rates.

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