Countries that maintain dollar pegs with their currencies must relax monetary policy when the US Federal Reserve relaxes monetary policy. Otherwise their currencies would rise against the dollar. Well, the Fed relaxed monetary policy in 2007 and into 2008 in order to prevent the popping of the housing bubble from causing a recession. But East Asian countries relaxed their currencies too. This sped up the growth rate of their demand for commodities and in doing so contributed to the rise in commodity prices. The rise in commodity prices pushes up prices over a large range of goods and services and could force the Fed to raise interest rates even as unemployment rises.
"The important thing to recognize is that we are more interconnected financially with the rest of the world," says Tim Duy, an economist at the University of Oregon in Eugene. "The expectation ... was that oil prices were going to go down" as the US economy slowed, but that didn't happen, he says.
One reason is simply that the US, while still by far the world's largest single economy, is now counterbalanced somewhat by fast-rising emerging nations. Their continued strength has buoyed both the global economy and commodity prices.
But Mr. Duy says that another factor may be at work – an unintended consequence of the Fed's recent interest-rate cuts.
When the Fed eases monetary policy to stimulate growth at home, other nations with currencies pegged to the dollar also have to ease their monetary conditions in order to maintain their exchange rates. The result is more money in the global system, which translates into more upward pressure on oil, food, and other prices.
"That linkage of domestic policy having global impact [and then rippling back into US consumer prices] is new for the Federal Reserve," Duy says. "If it is true, I think it does represent a significant change."
The inflation rate is already higher than the Fed acknowledges.
Nor has inflation spread across the rest of the economy. The core rate, which excludes food and energy, has been eerily consistent for a long time. In April, the annual core inflation rate was 2.3 percent higher than a year before. In April 2007, it was up 2.4 percent. In April 2006, 2.3 percent. A year before that, 2.2 percent.
I see two flaws in this argument. First off, the focus on "core inflation" is suspect since people spend real money on food and fuel. Second, rising commodity prices have squeezed producer profits and their input costs have gotten high enough that they are starting to pass along more costs.
Prices are 4.2% higher than a year ago. That is a substantial rate of inflation. The Fed has put other priorities ahead of price stability.
On an annual basis, inflation worsened for the first time in four months, running at 4.2 percent in May compared with a year ago.
The index, which rose more than economists had forecast, comes on the heels of repeated warnings about inflation from the world’s central banks. The chairman of the Fed, Ben S. Bernanke, joined other bank officials this week in focusing on higher prices, citing the economic damage wrought by the record run-up in food and oil prices.
Since the causes of inflation are worldwide only a worldwide recession will put a damper on inflation.
|Share |||By Randall Parker at 2008 June 14 12:36 AM Economics Trade|