Can The Fed Help Control Inflation?

Scott Simon talks to Alan Blinder, former vice chair of the Federal Reserve's Board of Governors, about whether the Fed can bring inflation under control in the face of spiraling energy and food prices.

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SCOTT SIMON, host:

This week, Fed Chairman Ben Bernanke told a congressional committee that a top priority of the Federal Reserve is to, quote, "run a policy that's going to bring inflation to an acceptable level." With the dollar falling and prices rising, what kind of policy might that be?

Alan Blinder was Vice Chair of the Fed's Board of Governors during the Clinton administration. He's now professor of economics at Princeton and a vice chairman of the Promontory Interfinancial Network. He joins us from Princeton. Thanks so much for being with us.

Dr. ALAN BLINDER (Professor, Department of Economics, Princeton University): My pleasure. Glad to be here.

SIMON: Can the Fed control inflation past a certain point?

Dr. BLINDER: Well, yeah, if you give it enough time. The Fed cannot control inflation over very short periods because all kinds of other things, like, for example, oil prices, interfere. But over long periods of time, it has pretty good control over inflation.

SIMON: Oil prices dropped about 10 percent this week. What's that a sign of?

Dr. BLINDER: I think it's a sign of actual and impending slackening in the world economy. And that's going to help the United States, as people have to spend less on oil and can spend more on other things. And it's also going to help the Fed control inflation.

SIMON: Professor Blinder, you must, and other economists, must be asking yourself if this represents some kind of epoch, or is this just a bleep?

Dr. BLINDER: Well, I wish I knew the answer to that. The fact is that oil prices are essentially unpredictable. I think the best guess we can make for near-term future oil prices is the same as they are today. I think over very long periods, Scott, we're going to have new technologies which are going to beat down the price of oil. But that's well into the future.

SIMON: How far should the U.S. government be willing to go to contain problems at Fannie Mae or Freddie Mac?

Dr. BLINDER: Far.

(Soundbite of laughter)

Dr. BLINDER: Regardless of what you think about the long run - that is, where should we be going with these enterprises - and regardless of what you think about the history that got us here, we can't let us these institutions fail. They are now one of the few things that have been propping up the housing and mortgage markets. I mean, you may know that over the last year since this crisis has broken out, Fannie Mae and Freddie Mac between them are accounting for about 75 percent of all the mortgages in America. I think as soon as you get your arms around that fact, you realize that under no circumstance can they be allowed to fail.

SIMON: Do you expect more regulation to be wrought into financial markets because of this current crisis?

Dr. BLINDER: Absolutely yes. I'll be shocked if it's not. I mean, the crisis, first of all, has shaken people's faith in laissez-faire and creative markets. Secondly, it has shown weaknesses in the regulatory system. I mean, there's a very long list of things that need to be fixed pertaining to our financial system.

SIMON: Like what?

Dr. BLINDER: Well, there have been problems with the rating agencies. They missed the boat very badly. There have been problems with the bank regulators who allowed these subprime and Alt-A and even ninja loans to happen. There are issues now raised by the fact that the Fed is lending money to brokerages, and implicitly maybe soon to Fannie Mae and Freddie Mac. And that raises questions about extending the Fed's supervisory reach to these institutions which are not banks and therefore have not been regulated before. There are other questions about whether we should have all these exotic derivatives, or try to be pushing things into more plain-vanilla formats that can be traded on exchanges...

SIMON: You mean - you mean some of these recent inventions being used...

Dr. BLINDER: Yes. CDOs, CDSs..

SIMON: Yeah.

Dr. BLINDER: Yes. And probably some things I don't even know the names of.

SIMON: Alan Blinder, professor of economics at Princeton, former Vice Chair of the Federal Reserve. Thank you so much.

Dr. BLINDER: You are very welcome.

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