Fig Leaf at the Economist
The Economist magazine is calling for another interest rate increase. They attempt to justify this with recent revisions showing that productivity has not been as high as formerly announced, and thus labor costs are rising rather fast. Thus inflation is not a temporary surge but a building tsunami, mounting higher and preparing to inundate the system. But those who are not caught up in the political maneuvering around the issue can easily recognize that this is the kind of “fig leaf” argument dragged in when the positions are already mainly fixed and the arguments are for public cover, rather than for any genuine persuasive merit. In exactly the same category goes the magazine’s dismissing the sudden fade in housing prices.
The important question is whether the Fed will recognize that monetary policy is already slowing the economy, or will somehow conclude that the policy must continue to get more restrictive until inflation numbers are actually falling. Such a call for completely choking off demand growth is always misguided, but in this context, where demand growth is primarily coming from outside growth in China (and India?), it is completely without merit.
The fact that the foreign growth is holding down finished goods prices, and doing so by substituting low cost labor for expensive labor in the richer world, should make us very skeptical about the chances for shutting down the demand pressure behind rising resource prices, or for wage pressures in the US economy to maintain momentum due to monetary effects of any kind.
The main number to concentrate on is the yield curve. It has been inverted for months. Currently short term rates are more than 20 basis points above long term rates. And the long term rates have been falling, which is sufficient to show that monetary policy is already slowing demand growth. That tells well enough why the housing market is weakening, and why the rest of the economy will be following fairly close behind. The point is that monetary restraint is already in place. (It is not such a good idea – see previous blogs). Adding to it is unnecessary – persistence is enough to achieve the goals desired by policy. Unless those goals are merely added income for asset holders.
Perhaps the Fed should be fighting world monetary pressure toward inflation? But the Japanese have been tightening, and the Chinese show some sign of restraining excess credit creation. The EU has had its interest rates on the high side for years, and shows no sign of excess monetary growth. Unless you somehow believe that many years of loose Japanese policy has built up an irresistible tide of money that has only now achieved the momentum to wreak its inflationary damage, the international monetary policy is already opposing inflationary demand pressure.
These are large topics with not enough time to elaborate, but suffice to say the Economist turns out to be more predictable than the economy.
The important question is whether the Fed will recognize that monetary policy is already slowing the economy, or will somehow conclude that the policy must continue to get more restrictive until inflation numbers are actually falling. Such a call for completely choking off demand growth is always misguided, but in this context, where demand growth is primarily coming from outside growth in China (and India?), it is completely without merit.
The fact that the foreign growth is holding down finished goods prices, and doing so by substituting low cost labor for expensive labor in the richer world, should make us very skeptical about the chances for shutting down the demand pressure behind rising resource prices, or for wage pressures in the US economy to maintain momentum due to monetary effects of any kind.
The main number to concentrate on is the yield curve. It has been inverted for months. Currently short term rates are more than 20 basis points above long term rates. And the long term rates have been falling, which is sufficient to show that monetary policy is already slowing demand growth. That tells well enough why the housing market is weakening, and why the rest of the economy will be following fairly close behind. The point is that monetary restraint is already in place. (It is not such a good idea – see previous blogs). Adding to it is unnecessary – persistence is enough to achieve the goals desired by policy. Unless those goals are merely added income for asset holders.
Perhaps the Fed should be fighting world monetary pressure toward inflation? But the Japanese have been tightening, and the Chinese show some sign of restraining excess credit creation. The EU has had its interest rates on the high side for years, and shows no sign of excess monetary growth. Unless you somehow believe that many years of loose Japanese policy has built up an irresistible tide of money that has only now achieved the momentum to wreak its inflationary damage, the international monetary policy is already opposing inflationary demand pressure.
These are large topics with not enough time to elaborate, but suffice to say the Economist turns out to be more predictable than the economy.