What's the biggest risk to the global economy today? There are so many choices - the credit crisis, the housing slump, skyrocketing food and oil prices, and more. The trickiest of these problems, though, is inflation.
Why inflation? For starters, many countries are trying to strike the right balance in terms of monetary policy, attempting to choose benchmark interest rates high enough to reduce rising inflation, without slowing growth more than necessary. Were inflation not a problem, monetary policy choices would be much simpler.
In addition, the likely consequences of inflation are unclear. Most traditional inflation measures strip out "volatile" food and energy prices, which makes sense under normal circumstances - but does it make sense today? Increasing food and energy prices are putting serious pressure on incomes and discretionary spending. However, economists usually worry most about inflationary expectations . If wages do not rise, will we see an increase in inflationary expectations in the overall economy? And what if oil and food prices stabilize at their current (if high) levels? It's hard to say.
This Fortune magazine article touches on some of these questions. Some of the economists Colin Barr has spoken too think the inflation risk is overstated - they argue that the credit crunch has only started to be felt in the real economy, and that housing prices will continue to decline, unemployment rise, and American consumers, after all these years of spending, will finally start to pull back. And slower economic growth - a true recession, which we aren't technically in yet - will constrain inflation.
Did Bernanke and the Fed take these considerations into account when cutting interest rates? It's quite possible that they did, and that these factors made them more comfortable with steep cuts in interest rates. Without a doubt, though, the risk of rising inflation is as high as we've seen in the last 30 years.
http://money.cnn.com/2008/05/08/news/inflation_crunch.fortune/index.htm?postversion=2008050903
Why inflation? For starters, many countries are trying to strike the right balance in terms of monetary policy, attempting to choose benchmark interest rates high enough to reduce rising inflation, without slowing growth more than necessary. Were inflation not a problem, monetary policy choices would be much simpler.
In addition, the likely consequences of inflation are unclear. Most traditional inflation measures strip out "volatile" food and energy prices, which makes sense under normal circumstances - but does it make sense today? Increasing food and energy prices are putting serious pressure on incomes and discretionary spending. However, economists usually worry most about inflationary expectations . If wages do not rise, will we see an increase in inflationary expectations in the overall economy? And what if oil and food prices stabilize at their current (if high) levels? It's hard to say.
This Fortune magazine article touches on some of these questions. Some of the economists Colin Barr has spoken too think the inflation risk is overstated - they argue that the credit crunch has only started to be felt in the real economy, and that housing prices will continue to decline, unemployment rise, and American consumers, after all these years of spending, will finally start to pull back. And slower economic growth - a true recession, which we aren't technically in yet - will constrain inflation.
Did Bernanke and the Fed take these considerations into account when cutting interest rates? It's quite possible that they did, and that these factors made them more comfortable with steep cuts in interest rates. Without a doubt, though, the risk of rising inflation is as high as we've seen in the last 30 years.
http://money.cnn.com/2008/05/08/news/inflation_crunch.fortune/index.htm?postversion=2008050903
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