Most other central banks put a single goal above all others: stable prices
(WASHINGTON) A nightmare scenario of rising prices and falling growth emerged on Wednesday as the US government reported that consumer prices are surging even as the beleaguered housing sector remains stuck in its worst slump in a quarter century.
The combination of inflation and faltering growth – the infamous ‘stagflation’ of the 1970s – creates a potential double bind for economic policymakers: Fight one and you risk feeding the other.
To the amazement of many analysts, however, the Federal Reserve Board signalled that it already has decided how it intends to attack that problem: By fighting the slowdown through continued interest rate cuts, while accepting the risk of higher prices.
In the minutes of its late January meetings and several conference calls released on Wednesday, central bank officials made clear that they would go for growth even if it means somewhat higher inflation.
‘In 2007, they were balancing their two objectives of price stability and sustainable economic growth,’ said Vincent Reinhart, former director of the Fed board’s division of monetary affairs. But now, said Mr Reinhart, ‘they care about growth first. They’re going to take a chance with inflation, and if you look at their projections they think they can get away with it’.
The danger is that prices will get out of hand as they did in the 1970s, and as they gave some hint of doing again in the report of January inflation.
The 0.4 per cent increase in the overall Consumer Price Index reported for last month was higher than analysts had expected. But what was most striking about the latest report was that the rises were not limited to the usual suspects, food and energy. Instead, they involved things that previously had fallen or remained stable – and thus had helped offset the recurrent food and energy increases.
Computer prices, for instance, which had tumbled 12 per cent over the past year, rose one per cent last month, said Stephen Cecchetti, former research director of the New York Federal Reserve Bank.
And restaurant meals, which have been stable till now, rose at a 4.9 per cent annual rate, he said.
And some analysts said the Fed’s decision to put boosting growth ahead of curbing inflation was almost immediately reflected in some new price increases. The benchmark gold price in New York rose to US$934.60 an ounce, up US$8, as investors snapped it up as a hedge against the inflation some fear the Fed will cause.
The Fed’s new priorities, together with tight supply, could have the same effect on oil. ‘I think oil has a shot at hitting US$150 a barrel before the end of the year,’ said Peter Schiff, CEO of Euro Pacific Capital, a brokerage house. ‘This is a highly inflationary period, and we’re creating the inflation.’
Over the past month, Fed leaders repeatedly signalled that their long-standing concern about inflation was giving way to worry about growth, housing and a freeze-up of the financial markets.
And the Fed’s policymaking Federal Open Market Committee made some of the steepest interest rate cuts in the central bank’s history in January.
But until Wednesday, the Fed had not said that it thinks rates will have to be held ‘relatively low’ for an extended period, as the newly released minutes do. Nor had it acknowledged that the low rates will mean somewhat higher inflation, as the forecasts included in the minutes effectively do.
‘Several participants noted that the risks of a downturn in the economy were significant,’ said the minutes of the Fed’s conference calls on Jan 9 and Jan 21 and Jan 29-30 meeting. ‘Many participants were concerned that the drop in equity prices, coupled with the ongoing decline in house prices, implied reductions in household wealth that would likely damp consumer spending.’ Some members of the FOMC said that when the economy had improved ‘a reversal of a portion of the recent easing actions, possibly even a rapid reversal might be appropriate’, said the minutes.
Still, policymakers suggested that their interest rate cuts are not feeding inflation as the economy is so weak there’s no pressure to push up prices. Their position was hard to square with the latest report of price rises and a pick-up in the speed of those rises.
The depth of the economic quandary in which the country and the Fed find themselves, and risk that policymakers are running in pursuing the strategy they have chosen is clearest when contrasted with that of other central banks. Most of the world’s central banks put a single goal above all others – stable prices.
‘The Fed is inverting that,’ Mr Reinhart said. ‘They’re putting growth first.’ Supporting the Fed’s slow-growth outlook, the Commerce Department said on Wednesday that housing construction puttered along at a 1.012 million home rate in January. That was a pick-up of 0.8 per cent from December’s pace. But analysts wrote off the improvement as a fluke.
Fed policymakers predicted that anaemic growth will nudge up the unemployment rate from its current 5 per cent to between 5.2 per cent and 5.3 per cent this year. That was up from their previous prediction of 4.8 per cent to 4.9 per cent.
Most strikingly, they forecast that the combination of their own growth-spurring interest rate cuts and other forces at work in the economy will cause inflation to rise faster than they had predicted previously. Using their favoured way of measuring inflation, they predicted an overall increase in prices of between 2.1 per cent and 2.4 per cent, higher than their previous prediction of 1.8 per cent to 2.1 per cent, and higher too than what was widely thought to be the outer limit of their comfort zone with inflation of 2 per cent.
Within the CPI, the so-called core inflation rate – excluding food and energy – was up 2.5 per cent for the 12 months ended Jan. 31.
Source: LAT-WP (Business Times 22 Feb 08)