Fed Chair Bernanke marks the Federal Reserve's centennial

Speaking before theNational Bureau of Economic Research Conference in Cambridge, MA., Chairman Bernanke reviews the Fed’s storied 100 year history including it’s successes and failures. Well worth reading. This was followed by a Q&A session that focused mainly on recent fed policy and which was very interesting.

He indicated that the current inflation rate of 1% is lower than the fed’s target of 2% but he believes that is due to transient factors which I did not hear him name. However if the rate does not rebound to something closer to 2%, that would be good reason to reconsider what the appropriate amount of monetary stimulus should be - read that as a return to more aggressive fed bond purchasing.

He also stated that as to both parts of the fed’s dual mandate - maximum employment and stable prices and interest rates - there was more work for the fed to do. But there were no real surprises in his remarks with any substantive remarks likely coming his Monetary Policy Report to the Congress (Humphrey-Hawkins testimony) next week.

edit: a transcript of his remarks will probably be available online shortly

I’ll just do this one shameless bump. The markets seem to have responded very favorably to the chairman’s remarks. We have a steepening yield curve which tends to support the prediction of further market expansion. Banks and financial institutions are most profitable when the disparity between long and short term rates is greatest. However in the short run, because of the effect on mortgage refinancings and other factors, the effect on bank balance sheets may be negative.

In addition, a flattening curve tends to precede an inverted yield curve which is strongly correlated with recessions. So this reversal supports the strong upward move in equities that we’ve seen this year prior the fed’s chair’s comments 6 weeks ago that many incorrectly interpreted as a prelude to fed tightening of monetary policy.

The increase in rates may also have the counter-intuitive result of stimulating lending since if the expectation is for rates to rise, individuals and firms that need capital for projects may feel compelled to move on those decisions sooner rather than later. If that happens, it will have the effect of expanding the money supply via the normal avenue of fractional reserve banking, which is what the fed had been attempting to stimulate since the 2008 crash.