Wednesday, July 16, 2008

Warning to the Federal Reserve

From Megan McArdle:
As inflation hawks go, I'm not particularly hawkish. I think moderate inflation is good, since it relieves the stickiness of nominal wages and helps the economy adjust to mild shocks. But the current inflationary cycle is moving past "moderate" into "dangerous" at a rapid clip. When the central banker tries too hard to balance unemployment and inflation, the result is creeping inflation that eventually has to be shut down painfully--just ask Paul Volcker.

The Federal Reserve has spent 25 years winning back the inflation fighting credibility that it lost during the 1960s and 1970s. Inflation has been fought so successfully that inflationary expectations are no longer even a glimmer in peoples' financial calculations. But a few more months of this, and that will start to change. The Federal Reserve will have to clamp down, hard, to prevent high inflationary expectations from being written into contracts and labor agreements. Better a moderate recession now than a really severe one when the Fed has to wring the inflation out of the economy.

Worse yet, the Fed's credibility will be much harder to rebuild the second time around. Once is an aberration; twice is a pattern. It's time to bite the bullet and raise rates.
I'm not in a panic yet (despite travails of my own and those around me) but I do see the warning signs around.

My problem, like most Americans is that the normal indicators of economic health or crisis are not in agreement.

No comments: