The market has not reacted well to the news that consumer price inflation increased at the fastest pace in decades last month.
This is normally where I drag out the tired notation that core inflation, which excludes food and energy prices, ticked up much more slowly. Then one of my commenters points out that ordinary people don't get to exclude food and energy from their budget. Then I respond that, yes, this is true, but from the Federal Reserve's point of view, the fact that certain staple commodities have become relatively scarce does not tell them much about managing the money supply.
Consider that we've had that debate. What does this news mean?
For individuals, it is bad; it means they are paying more for the same basket of commodities they consumed a month ago.
For money supply managers, it is much less bad, but still bad: the rise in core inflation indicates that monetary policy may be too loose.
That's normally not something you want to hear when you're trying to avert a credit crunch and an increasingly likely-looking recession. This news much reduces the Fed's scope for policy response to the subprime problems.
Still, I wouldn't panic just yet. Inflation has been low enough, for long enough, that the Fed has a couple of months worth of random expansion in it, if it's really needed. And I'm not sure that it's really needed.
The market is upset, because the market likes to borrow cheap money. But you shouldn't pin your assessment of the economy, or the future, on the Dow.
The market is upset, because the market likes to borrow cheap money. But you shouldn't pin your assessment of the economy, or the future, on the Dow.-M. McCardle
A strange comment from someone who was just recently asserting the perfect efficiency of markets. Regardless, I basically agree with the post above...
I don't worry about monetary policy much becuase I have a great deal of confidence in Ben Bernanke. He understands as well as anyone the problems that come from deflation or high inflation and how to prevent them. It's just hard to see the Fed repeating the mitakes of the 20's and 30's or of the 60's and 70's.
So, to quote the sage, "don't worry, be happy."
what's your take on this:
http://www.shadowstats.com/cgi-bin/sgs/data
and :"This week’s announcement by the Fed that it will create a new mechanism to provide funding for credit challenged banks has been lauded by Wall Street as an innovative approach to solving the credit crisis. In truth, it is really just the same response the Fed has had for all problems great and small: crank up the printing presses, shower money on the problem, and hope that financial pain can be obscured by the balm of inflation. Both the Fed and Washington politicians are completely clueless regarding the ill effects of the plan, and are simply acting in desperation to keep a ticking time bomb from exploding before the next election.
The Fed and other foreign central banks will provide this liquidity by auctioning low interest rate loans to holders of U.S. mortgaged-backed securities. The loans will be made under the same terms currently in use at the Fed’s “discount window”, with the added benefits of even lower interest rates and anonymity (borrowers wish to avoid the public stigma that comes from utilizing the discount window). Since the loans can be collateralized by mortgage-backed securities, the Fed will be on the hook should these loans not be repaid. In other words, the losses will simply be monetized, or more precisely socialized, as they are passed to the public in the form of inflation.
To get a sense of the losses that potentially await the public, in a recent transaction, E-Trade Financial liquidated its entire portfolio of subprime mortgaged-backed securities for a mere 27 cents on the dollar!
The hope that this additional credit will somehow alleviate the problems in the U.S. housing market is extremely naïve. Virtually none of this newly created credit will find its way back into the domestic mortgage market. With our real estate prices still too high, the gathering potential for lenders to be forced to assume liability for “unsophisticated” borrowers, the added uncertainty regarding mortgage terms, and the persistent weakness in the U.S. dollar, such loans will be far too risky for most foreign lenders to consider. Instead, these banks will take this cheap Fed money and invest it in higher yielding assets overseas. Off-loading risky U.S. mortgages to the Fed in exchange for cheap loans that can be used to finance better yielding foreign investments could well develop into the next carry-trade of choice."
http://www.financialsense.com/fsu/editorials/schiff/2007/1214.html
RWE:
You have trust in "B-52 Ben" Bernanke? A guy that rolls over when ever Wall Street whines? Bernanke has zero credibility. None!! Any clear thinking person could see the sub-prime meltdown coming. And regular people knew inflation was heating up. Do you know why the Fed stopped publishing the M3? Why has the Fed been printing money like there is no tomorrow? Hell, Citigroup is hanging on for its life. Is that serious enough for you?
JKC, you're a very good comedian, but I'm not sure about your economics. We'll see.
1)"Any clear thinking person could see the sub-prime meltdown coming."
I've heard people blame Greenspan for this, but not Bernanke. What was he supposed to do? The risky lending mostly took place before he became Fed Chairman.
2)Do you know why the Fed stopped publishing the M3?
I remember them complaining about the costs of data gathering. I always thought that M2 was a better measure of the money supply--that's Milton Friedman's influence I guess--and M2 wasn't growing all that quickly even when rates were very low, according to Greenspan's recent Journal op/ed.
Anyway, the Fed target's the Federal Funds Rate now, and probably has an implicit inflation target as well, but it doesn't target monetary aggregates anymore.
3)Why has the Fed been printing money like there is no tomorrow? Hell, Citigroup is hanging on for its life. Is that serious enough for you?
I don't understand. The Fed is running a looser monetary policy than it otherwise might to address the credit crunch. Hell, even McCardle knows that. Now, that should help Citigroup. What do you want, tighter money? That sure wouldn't do Citigroup any good.
And anyway, while the Fed should concern itself with the overall health of the economy, it's not the Fed's job to save Citigroup from the consequences of its own blunders. That company is feeling some pain, but it desrves too. They made some bad decisions there.
***
Maybe you'll show me I'm wrong. I hope so. I'm always happy to learn, though I do know a fair amount about economics already.
Personally, at the moment I'm trying to make as much money as possible and spend as little of it as possible. I realize that in the aggregate, if everybody stops spending, it increases the likelihood of recession. But on an individual basis, I have to take the threat of a recession pretty seriously, so it's time to save.
I don't worry about monetary policy much becuase I have a great deal of confidence in Ben Bernanke.
Don't you consider it a trifle weird, for someone who believes that markets make superior decisions to central planners because no individual can possibly take into account all the information that percolates through the trillions of decisions that compromise markets, that's you're making your assessment of the likelihood of a stagflation problem on your assessment of the personal characteristics and acumen of one guy? Aren't there occasionally objective situations which surpass the capacities of one guy leading the central banking board to overcome? I mean maybe you have confidence in his ability to make the best possible monetary policy decisions under the circumstances, but what Megan is talking about here is the possibility that the objective situation of a looming recession, steep hikes in energy prices and the plummeting dollar driving higher inflation, and a worldwide credit crunch driven by a housing price collapse will make it impossible for any monetary policy to simultaneously avoid recession and inflation. "Oh, Ben will get us out of it" seems like an odd thing to say in response.
Free market decision-making is almost always superior to governmental? Of course it is. Capitalism will make you richer than socialism (and safer and healthier, certainly freer and possibly happier)? Yup. Our science and technology has been advancing by leaps and bounds? Largely. And yet the whole edifice is based on this strange fiat currency business, run by all-too-fallible humans (giving Mr Greenspan the benefit of the doubt). How very odd it all is.
brooksfoe, you make a good point. I should really have said that, first and foremost, I have a great deal of confidence in the flexibility and dynamism of the American economy. And, in the context of an economy that is very resillient to shocks, I'm especially pleased that we have a Fed chairman who is unlikely to repeat past monetary errors. How is that? Better?
Incidentally, that confidence is not blind faith. It's based on experience. We are having fewer and shallower recessions than we used to. There are many reasons for that, but one of them is the deregulation that increased flexibility in the financial markets and elsewhere. Alan Greenspan put the case well here.
Anyway, I'm not worried. America is in very good shape. If there is a recession, it will likely be mild. The dropping dollar stimulates net exports, so that doesn't worry me either. And high and sustained inflation is only possible with poor monetary policy, which isn't likely.
You and McCardle panic if you want to. I'm in good cheer.
"Should we panic?"
Unless you believe that some plausible set of conditions would lead you to answer that question in the affirmative, it's the wrong place to start. Asking whether people should act irrationally and then deciding that it wouldn't rationally make sense to do so is a clever little exercise, but it doesn't add to our understanding.
Answer this for me instead: Should we (Americans) scale back our borrowing and spending and speculating in an attempt to increase our savings and low-risk investments, protecting what's ours at the expense of the global economy's continued growth?
Would it be more accurate / less confusing to rename the two metrics "currency inflation" and "price inflation" or something like that?
One small correction. It was wholesale prices (the PPI) that had their biggest jump since 1973. The headline CPI report up a lot, the most in two years.
A scarcity of energy and good staples driving up their prices is a much bigger problem than mere currency inflation, albeit one that is not for the Fed to address.
Regarding core inflation: It is my impression that the point of core inflation is that energy and food prices are volatile. The Fed doesn't want to overreact when something goes up a lot that also goes down a lot for reasons unrelated to growth rate in the monetary supply. Fair enough.
But I see a problem with always excluding food and energy: Sometimes they go up for much longer periods of time. We are in one of those periods. Their shift upward is part of the inflation that everyone experiences.
Maybe the Fed should run Kalman filters on prices on goods that fluctuate a lot. Use different filtering algorithms on different inputs would allow use of complete market baskets without overreacting to transient price changes.
Eh, I don't think it's correct to say that "the fact that certain staple commodities have become relatively scarce does not tell [the Fed] much about managing the money supply" is the reason the Fed pays attention to core inflation. Last month (following a report from the Kohn/Yellen committee), Bernanke issued a statement (the same one that extended forecast horizons from two to three years) clarifying that the Fed's concern is headline PCE, but that core PCE was valuable as a leading (and less noisy) indicator.
The Dow (OK, the market as a whole) is pretty much a collective assessment of the future of the economy. It's the price we're willing to pay for future earnings.
Randall_Parker: No need for a fancy Kalman filter. Just use a running n-month average ;-)
The price index of stuff I care about is going asymptotic on the y axis. This is the price of not being poor and not being rich and not being particularly interested in consumer electronics.