Is the Media’s Focus on Inflation Warranted?
As the end of summer nears and the beginning of fall approaches, financial news has seemingly made a transition in coverage from the recession to fears of inflation. While I certainly would agree that we need to be mindful of this potential danger, I think current economic conditions do not warrant the attention it has received. The group charged with monetary policy seems to have the same opinion.
In the latest press release from the Federal Open Market Committee, they touch briefly on inflation:
The prices of energy and other commodities have risen of late. However, substantial resource slack is likely to dampen cost pressures, and the Committee expects that inflation will remain subdued for some time (Aug. 12th 2009).
Translation – There are a lot of people out of work, and inventory (or capacity for inventory) is higher than demand. This means retailers are pressured to keep prices low and it will be difficult for wages to increase enough to support high inflation. In addition, the housing market is still weak and credit conditions remain strained. All of these factors lead to reduced consumer spending, which ultimately keeps the risk of substantial inflation low in the short term.
I will agree, however, that we do run the risk of over stimulating the economy. The massive expansionary policies will be hard to unwind once the recovery takes hold; there may also be political pressure to keep interest rates low and government programs going. In the meantime, Fed chairman Ben Bernanke sounds confident that they will be able to slowly tackle any future inflationary pressure, mostly through raising interest rates and reducing the supply of money.
While we can’t know how severe future inflation might be, at some point, the Fed will likely determine that the risk of inflation is high enough to cause action. Make the call too early, and you risk going back into a recession; make it too late, and inflation becomes more difficult to manage. High inflation leads to higher interest rates and less borrowing. Businesses have to pay more to borrow, which drives down new investments and consequently, a decrease in job creation. As the economy recovers, the Fed will keep a close eye on various economic indicators to keep prices as stable as possible. It will be a difficult set of decisions for the Fed chairman to make.
How would you handle that decision? To get a better understanding of what the Fed does and how interest rates, inflation and unemployment impact each other click here. You’ll also find a game that allows you to control monetary policy in a simulated economy.
Time will tell whether the increased concern and media attention about inflation is warranted. At the very least, it is understood, given the massive expansionary policies used during the financial crisis. The Fed and politicians alike will continue to try to balance the threat of extending recession with the danger of bringing on excessive inflation. My guess is it will be some time before we see a policy shift focused on inflation; in the meantime, the debate will continue.
What do you think?
Kevin Jaegers, Senior Investment Advisor
September 3rd, 2009 at 9:28 am
I think you’re right. From what I’ve read, inflation isn’t the bugaboo in the near term. If there’s two things we can count on, it’s volatility and increased regulation. WSJ recently outlined three scenarios–robust recovery, sluggish and double dip with convincing arguments for all three! In Bernanke, we trust.
September 4th, 2009 at 2:14 pm
We have recently heard news about Bernanke. Bob Brinker, of “Moneytalk” fame claims he is really great. But then I heard another person, that I respect (can’t remember who it was), say that he was not that great was was in fact not doing a good job at all. That person went on to tick off the reasons why he/she thought that. Brinker did not give reasons for his opinion. As usual, I did not know what to think. Do you have an opinion and some good reasons for having that opinion?
September 4th, 2009 at 6:37 pm
Good question Roger. I have a fairly balanced opinion of him right now. I think he could have done a better job in recognizing a bubble was forming and been more proactive in dealing with the early stages of the crisis. Once he decided to take action though, I think he has effectively taken the steps needed to pull the U.S from financial disaster and helped guide the global coordination of action. I also believe he’s well-qualified for the position; beyond that, I think it will be tough to evaluate his performance until well in the future. It will be interesting to find out what the perception is from a historical perspective.
For more information, you may want to take a look at a previous post (Bernanke II: Did he get the job, and how is he doing?) where we discussed some actions he took over the past year in dealing with the recession. As always, thank you for reading and taking the time to comment.
Kevin