Tim Duy Sees Stagflation Much Closer than the Horizon

Tim Duy on monetary policy:

Economist's View: Fed Watch: This Train Doesn't Stop: A choice has to be made in the short run. Focus on inflation, and hold policy relatively tight? Or focus on growth, hoping that soft economic growth will tame inflationary pressures? The Fed continues to choose the latter path. In truth, at this point they have no other choice. It was unlikely that the Fed could bring a halt to this easing cycle as long as economic data point at recessionary conditions; this was always the danger of moving so quickly early in the cycle. And it became unthinkable to back away from the current set of policies after Congress followed up on Fed Chairman Ben Bernanke's push for fiscal stimulus. The die is cast. Look for another 50bp in March and then two more 25bp cuts at subsequent meetings to bring the Fed Funds rate to 2%....

[I]ncoming price data are difficult to ignore, and left the Fed revising upward their near term inflation expectations.... Still, the expectation is that inflation will moderate in the months ahead....

Not surprisingly, Bernanke's inclination to continue pushing rates lower is resonating throughout financial markets. Inflationary pressures are building globally (note that China is completing the chain that leads to an inflationary spiral, setting the expectation that high inflation will be matched by higher wages), reflected in surging commodity prices and the freefall of the dollar. The former is weighing heavily on US consumers. Indeed, I am amazed that this story is only starting to capture the attention of the press. So much attention is placed on the housing market as the source of declining consumer confidence, but over the last three months, headline CPI has surged 6.8% annualized. Sure doesn't look like nominal wages gains are keeping up. No wonder confidence is collapsing.... Not a pretty combination of events. And Bernanke knows it:

Upside risks to the inflation projection are also present, however, including the possibilities that energy and food prices do not flatten out or that the pass-through to core prices from higher commodity prices and from the weaker dollar may be greater than we anticipate. Indeed, the further increases in the prices of energy and other commodities in recent weeks, together with the latest data on consumer prices, suggest slightly greater upside risks to the projections of both overall and core inflation than we saw last month.

But the bottom line is that he can't stop the rate-cutting train now. He can only hope that inflation expectations remain reasonably well anchored while his attention is focused on the deteriorating growth outlook. To pull this off, Bernanke will have to hope for minimal nominal wage growth. I don't know if this will be a political feasible outcome after the period of real wage stagnation experienced during the Bush Administration...

Comments

[esb]

Due to a technical publishing (software) error the word between Train and Doesn't seems to have neen dropped.

That word, of course, is "wreck."

[howard]

i've said before, in this very space, that i thought that stagflation lite (and the policy dilemma currently facing the fed) was the logical outcome of bush league economics, so i will only add that i don't understand why slowing growth should, in particular, moderate the kinds of price increases we have been seeing: i don't think american growth is the marginal driver.

[bakho]

Did the necessary compromise kill most of the stimulus effect of the Bush deal with Congress? Limiting all fiscal intervention to "tax cuts" is silly and counterproductive. Fiscal policy is adrift.

[christofay]

We've had stagnating wages and creeping inflation, though how the CPI is calculated helps to mask this, all through the Bush years. What's the still highly anticipated but yet to be announced secret? It's existed but isn't officially acknowledged until some guy with a PhD makes an announcement that is accepted by everyone in academia, I guess. Hire more working economists, Roubini, Kasriel, is the antidote, I guess. Send Greenspan to Saudi Arabia and Bernanke to China to confuse our enemies, too, I guess.

[ricardo]

I'm with bakho...Bernanke's greatest legacy would be to come forward now and demand responsible fiscal policy - monetary policy alone can't begin to address the flawed economic fundamentals in place at this time.

If, God forbid, Bernanke simply summoned the will to begin the necessary conversation - for example, to tell Congress when he next testifies that it is imperative that we reduce the deficit - some of the present run on the dollar might even be checked...

[christofay]

Sure, let's stop spending on the kids' dime, calls for trillion dollar financial firm bail-outs, high Pentagon spending, high spending to benefit the farmer special interest group, ethanol socialism, private Pinkerton spending, private government contracting, Iraq spending to find Cheney's missing oils, should all be big fat sacks of cash to curtail.

Ain't gonna happen.

[Roger Bigod]

I'm having trouble with the Big Concept here. Apparently, we got into this trouble because the Fed kept interest rates too low, for too long. So the solution is to lower interest rates? Am I a retard or what?

Didn't the Japanese do something like this? Has anyone checked lately on how it's worked out for them?

[Julian Elson]

I'm not quite sure why Krugman seems to believe that stagflation isn't likely, and that all that's needed is fiscal stimulus to put everything to rights. Sure, wage growth has been depressed, but profits have been growing quickly over the past few years; if a wage-price cycle could happen in the 70s, why couldn't a profit-price cycle happen today? Sure, you might say that companies can't raise prices much, since most people who don't own many shares in profitable companies don't have more spending power, but those dividends are going somewhere, whether to more spending on luxury goods and services or to savings which could be lent our to wage workers who could maintain their standards of living despite rising rising prices and stagnate wages through increasing indebtedness. Ultimately, the income and spending sides have to be equal, and the accounts have to balance. I don't see why they balance right now in such a way that points toward subdued inflation.

[bakho]

Was some stagflation caused by labor strikes and rising wages? What would cause wage inflation at this point in the economy? Both the domestic jobs numbers and global labor market ensure that labor is not in position to inflate wages.

Isn't higher interest rate supposed to hit inflation by decreasing the number of jobs? Since we are already bleeding jobs, would a higher interest rate really target inflation? How would that work? Drive down energy demand to get a price drop? With global oil demand high, how would that work?

[Cranky Observer]

> f, God forbid, Bernanke simply summoned the will
> to begin the necessary conversation - for example,
> to tell Congress when he next testifies that it
> is imperative that we reduce the deficit -

The problem for a Democratic Congress is the old saying "fool me once, shame on you; fool me 27 times, shame on me". While what you suggest might make sense in a rational world, the history of the last 30 years has been Democratic administrations and congresses cleaning up messes and absorbing the blame for doing so followed by Republican administrations and congresses creating new and bigger messes in the course of transferring trillions of dollars of wealth to their very rich friends. It is hard for me to see (from either a citizen's or a game theorist's perspective) why the next Democratic Congress should go along with that again.

Cranky

[Neal]

The main ailments of the economy are:

The collapse of the ATM economy of the real estate bubble.

The collapse of the mortgage securitization process.

The loss of jobs due to the basic non-world-competitiveness of the US worker that was disguised by the on-site and near-site labor needs of the real estate bubble.

The upward pressure on prices that is coming from the world competing for commodities that have limits in supply or production.

The unsustainable nature of the governments economic policies.

The unsustainable nature of the governments foreign policies.

Will rate cuts cure these problems? No, in fact they have no effect or make them worse. The only potential hope is that the dollar falls far enough that the uncompetitive nature of US labor less true. But this is not good news for the US worker--their wages will not go up but their costs certainly will.

[piotr]

Well, low interest rates drive dollar lower, and this makes domestic products more competitive.

If we also showed more elasticity in our gasoline consumption, the combined effect would quickly reduce the trade imbalance.

Several aspects of the "main ailments" listed by Neal are, basically, necessary corrections. Mortgage securitization will exist, but with improved sorting into less and more risky securities.

There is even a solution to stop the average wages from decreasing: include CEOs in calculations, with all their benefits and bonuses.

[Emma Anne]

"The problem for a Democratic Congress is the old saying "fool me once, shame on you; fool me 27 times, shame on me". While what you suggest might make sense in a rational world, the history of the last 30 years has been Democratic administrations and congresses cleaning up messes and absorbing the blame for doing so followed by Republican administrations and congresses creating new and bigger messes in the course of transferring trillions of dollars of wealth to their very rich friends. "

Cranky nails it nicely. I especially like "fool me 27 times."