Don’t Blame Bernanke

September 5, 2008 • Commentary
This article appeared in Forbes​.com on September 5, 2008.

When the price of crude oil shot up from $100 in early March to $145 in early July, several old friends in economics and journalism blamed it on the Federal Reserve.

The low fed funds rate caused the dollar to fall, they argued, which fueled a boom in commodity prices. Even the price of rice was blamed on Ben Bernanke. The Fed was said to be printing money with abandon, even though the monetary base is up 2% over the past year.

Now that the dollar has been rising and commodity prices falling, consistency requires the Fed’s critics to explain the current situation as the result of a higher fed funds rate. But the fed funds rate isn’t higher.

And now that the British pound is at a 2.5-year low against the dollar, consistency requires those who blamed the pound’s previous rise on the Fed to now complain that the Bank of England has kept interest rates much too low.

Making strong statements on the basis of weak theories gets awkward when the facts turn against you. But this Fed‐​dollar‐​oil theory never had much to do with facts.

The big surge in oil prices from March to June happened when the dollar was not falling. The Fed’s broad index of the dollar’s value was 95.8 in March when crude oil averaged $105, and 96.1 in June when crude reached $134. (And it rose to 97.9 in August when crude was below $117.) Rising oil prices went hand in hand with a stronger dollar, not a weaker one.

The surge in oil prices also happened when most other commodity prices were not rising: The Economist index of commodity prices (which excludes oil) fell from 271.9 on March 4, to 250.6 by June 3 and to 234.8 by Sept. 2.

On June 6, when crude oil first hit $138 a barrel, I wrote “Get Ready for the Oil Price Drop” in the New York Post. That was not because I was expecting the Fed to tighten. It was because I expected steep oil prices to cause real gross domestic product to fall in places like Germany, France, Ireland, Sweden, Japan, Singapore, Hong Kong and New Zealand.

When comparing June or July “headline” inflation with figures from a year ago, they look temporarily high in the U.S. and Europe because oil prices doubled. Arithmetically, the only way year‐​to‐​year headline inflation could stay so high would be for oil prices to double again by next June, to nearly $300 a barrel. That won’t happen.

Rajeev Dhawan and Karsten Jeske of the Atlanta Fed found that using headline inflation to guide monetary policy “appears to be a bad idea, both in terms of the output drop and the inflation impact.”

The Fed finally understands that. But the European Central Bank and Bank of England opted to define rising oil prices as inflation and to ease only after their economies implode–as the Greenspan Fed did by pushing the fed funds to 3% on Sept. 4, 1992, and to 1% on June 25, 2003. Bernanke’s timing is much better.

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