Tame Inflation Just Growled – Is the Fed Listening?

Tuesday, January 25, 2011

The Wall Street Journal’s lead article says it all: “Global Price Fears Mount” (By Brian Blackstone and Marcus Walker, January 24, page A-1). Rising inflation concerns have reached the “something must be done” stage. Everywhere except here in the US, that is.

Now that anti-inflation actions (i.e., interest rate increases) are being discussed or taken elsewhere, will the Fed respond in kind?

The world view of inflation

From the WSJ article:

“Inflation fears – fueled by spiraling food, oil and raw material prices – are mounting around the globe, prompting the head of the European Central Bank to signal that it could raise interest rates in the future even though some countries have been weakened by the Continent’s debt crisis.”

The US view of inflation

In the US, inflation concerns also have been voiced – just not officially by the Federal Reserve. There have been efforts to influence the Fed, such as the “New Push at Fed to Set an Official Inflation Goal” (The Wall Street Journal, by Jon Hilsenrath, January 24, page A-2).

“Proponents say adopting a formal objective would blunt criticism of the Fed that current easy-money policies could lead to an upward spiral in consumer prices….”

However, the opposing view is that the Fed should keep focusing on its dual mandate “to foster maximum employment and price stability.” Supporting this argument is the Fed’s statement that “longer-term inflation expectations have remained stable, but measures of underlying inflation have continued to trend downward.” (All Fed comments are from their December 14, 2010 meeting statement.)

Could the Fed’s view change at this week’s meeting?

Expectations have been for no change. However, recent reports certainly require the Fed to focus on their price stability goal.

Likewise, they need to consider their view that “Employers remain reluctant to add to payrolls.” Indicators have been showing improvements, including “More Hiring Expected as Gloom Starts to Lift.” (The Wall Street Journal, by Luca Di Leo, January 24, page A-3).

What might change?

The Federal Reserve Open Market Committee’s meeting statement will come on Wednesday (at 2:15 PM EST). The likely changes will be a tempering of their previous, negative economic views.

A significant change would be in their interest rate decision paragraph – particularly an altering of the highlighted “e-words”:

“The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.”

So… We need only wait until Wednesday to find out what the Fed is thinking. Does it still see inflation as tame or do those growls change their view?

Keep in mind:

Short-term rates are indeed “exceptionally” low. If the Fed changes either of the e-words, we may read that it is planning on “tightening.” That description is wrong. The rates are now abnormally low. Left on their own, the rates would rise to a “normal” level determined by the markets. Tightening occurs when the Fed increases rates above the normal. We have a long way to go before that happens.

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John Tobey on Seeking Alpha

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January 2011