Bernanke: Hard For Policy To Address Market Bubbles

Central bankers are limited in identifying and addressing asset price bubbles, and such disruptions are in any case a hard-to-avoid side effect of having a dynamic financial sector, Federal Reserve Chairman Ben Bernanke said Monday.

"It is very, very difficult to ascertain whether a bubble is in progress early enough in the process to address it effectively using macro and monetary policy," the central banker leader said. Bernanke was speaking at a gathering of the Economic Club of New York, and his comments came in response to questions from Henry Kaufman, of Henry Kaufman & Co., and Bear Stearns Chief Economist David Malpass. The chairman's remarks arrive at a challenging time for the central bank. The Fed responded last month to the recent market trouble and its negative implications for growth with an aggressive half-percentage-point rate cut last month, and for some time, most on Wall Street have expected to see further easing. But a string of recent economic data, from jobs numbers through to retail sales, has shown surprising resilience in the face of the gyrations of the financial sector. For some, the data are calling into question the need for additional rate cuts, and futures markets have largely priced out of the market any additional move lower in what is now a 4.75% fed funds rate. In his formal remarks, the central bank leader had said "the improved functioning of financial markets is a positive development in that it increases the likelihood of achieving moderate growth with price stability." But Bernanke had also warned it remains "uncertain" what impact the market troubles will have on overall economic growth. He added the Fed "will continue to watch the situation closely and will act as needed to support efficient market functioning" along with promoting growth and price stability. Bernanke's post speech remarks were wide ranging, and addressed the limits central bankers have in remedying market problems. "One of the downsides of innovation is that sometimes you make mistakes and have problems," Bernanke said, referring to some of the troubles that have beset financial markets over recent months. On the matter of technological change and the rise of things like subprime mortgage lending, he said "if we want to have innovation and growth and productivity and change and dynamism, we have to let the system work and we have to sometimes have problems."

Important For Flexible Exchange Rates In Large Economies

Referring to the root of the current troubles, namely understanding the pricing and risk profile of many types of securities, Bernanke said "there is no totally satisfactory solution" to the problem. "The best answer" to a better valuation process "is that the firm or vehicle in question needs to be as transparent as possible about what it is and how it values its assets." Bernanke added some of the current stress in markets represents an "information problem, and it will take a while for investors to appropriately value" the assets they hold. The central banker also said it was particularly valuable the insights the Fed has gained into banks' health as a result of the Fed's regulatory activities. The Fed chairman also commented on the dollar's shifting value on U.S. inflation dynamics. Bernanke said, "it is important that we pay attention to (exchange rates) and figure them into our calculations." "One cannot deny that all else equal, when the dollar depreciates there is some inflationary effect," Bernanke said. But, "our experience over the recent decade has been that those effects are relatively small." He also said it's important for large economies to have flexible exchange rates. The Fed chief also said in his post speech remarks that while there does appear to be somewhat of a short-run tradeoff between growth and inflation, "over the longer period, we now understand low inflation is essential for solid economic growth to persist and be sustained." Bernanke added "we at the Federal Reserve will be very focused" on achieving that low inflation goal. Bernanke also said that in the long running debate over the low savings rate in the U.S., it's more important to weigh overall wealth levels, rather than just how much money is saved.