It's the sort of news that strikes fear in the hearts of incumbent politicians everywhere: the cost of living is rising. And if people really do vote with their wallets, less money in their pockets is a death knell. With the U.S. consumer price index rising 0.4 percent in February -- the largest jump in 10 months, largely due to rising gasoline prices -- the trend doesn't look good. On March 23, the International Energy Agency warned that soaring oil prices risk a recession. And in a testament to the issue's political resonance, GOP candidate Newt Gingrich even pledged (however utopian this may be) to lower the price of gas to $2.50 per gallon in an effort to revive his flagging presidential hopes.
But while rising gas prices may dim President Barack Obama's reelection prospects, Federal Reserve chairman Ben Bernanke is not likely to lose much sleep over it. Bernanke's own research, dating back to 1995, has convinced him that it is central banks' decision to tighten the money supply by raising interest rates that triggers economic downturns -- not the spike in oil prices itself. And so long as the Fed doesn't raise interest rates in the face of rising oil prices, Bernanke's thinking goes, the spikes should be harmless. Even if oil prices were to jump through the roof, it is highly unlikely that the Federal Reserve would raise interest rates in an effort to combat inflation.
How can we be so sure of that? Under Bernanke's stewardship, the veil of secrecy over the Fed's actions that existed under his predecessor, Alan Greenspan, has been lifted. Back in those days, being a Fed-watcher was an actual profession -- trying to decipher what Greenspan himself dubbed Fed-speak: mumbling with great incoherence. Bernanke, on the other hand, vowed during his confirmation hearing in 2005 to make the Fed's policies more transparent. When financial markets can predict the factors that affect the Fed's monetary policy, his academic research had convinced him, it is easier for him to keep interest rates where he wants them.
When Bernanke sent his second monetary policy report to Congress in June 2006, he told lawmakers that the decision on a possible rate hike would depend on incoming economic data. No crystal ball -- simply data-driven decision-making. But this announcement didn't have the stabilizing effect that he probably had hoped for: Financial markets fell in disarray, as some data pointed to a rate hike while others suggested that the Fed would keep the rate steady. As one banker at Lehman Brothers mused at the time, "Bernanke is treating us like adults, only to find out we are behaving like children."
When credit markets choked up and international trade plunged after the collapse of Lehman Brothers in September 2008, Bernanke not only flooded the banks with money to keep them afloat, he also quickly cut interest rates. Since then, he has acted to keep rates at historic lows in an attempt to spur economic growth -- a step, however, that also appears to contribute to rising oil prices, and hence rising inflation.
With the federal funds rate -- the most important short-term rate that the Fed has to influence the economy -- at almost zero percent since December 2009, Bernanke has been forced to look for unconventional ways to stimulate the economy and combat high unemployment. He embarked on a strategy of buying trillions of dollars of bonds known as quantitative easing, which aimed to unfreeze the market for asset-backed securities and drive down longer-term interest rates.
In a bid to enhance the Fed's predictability, Bernanke also launched a policy of holding press conferences immediately after the meetings of the Federal Open Market Committee, which determines short-term interest rates. The pressers are intended to "further enhance the clarity and timeliness of the Federal Reserve's monetary policy communication," according to a press release at the time.
In the past year, Bernanke has only doubled down on his efforts to use the Fed's communications policy to drive down interest rates by giving investors still more guidance on the future path of the Fed funds rate. On Aug. 9, 2011, the FOMC released a statement saying that it anticipated economic conditions would likely warrant exceptionally low levels at least through mid-2013. This sent shockwaves through financial markets -- the volume of stocks traded rose to almost twice the daily average. The FOMC succeeded in its mission to lower bond yields, but it also effectively limited Bernanke's flexibility to alter course in the face of changing market conditions.