Inflation data put Bernanke in a bind

December 15, 2007|By McClatchy-Tribune

Among the many things to be thankful for this holiday season is that you're not Federal Reserve Chairman Ben S. Bernanke.

He's besieged by turmoil in the credit markets, Wall Street clamoring for more interest-rate cuts and now inflation data that might tie his hands as he tries to keep an economic slowdown from snowballing into recession.

The Bureau of Labor Statistics reported yesterday that consumer-price inflation jumped 0.8 percent in November, the largest increase since the aftermath of Hurricane Katrina. That bumped inflation felt in consumers' wallets up 4.3 percent over the past 12 months.

Energy prices alone are up 21.4 percent over the past 12 months; food prices rose 4.8 percent over the same period. But when volatile energy and food prices are stripped out, core inflation rose only 0.3 percent to a 2.3 percent annual rate; still, that's above the Fed's perceived comfort zone limit of 2 percent.

It creates a dilemma. The economy is expected to slow early next year, and usually the Fed's response would be to lower interest rates to spark economic activity. But that fuels inflation, the rise of prices across the economy.

"What you perceive is the Fed's job is becoming very difficult moving into 2008," said Kenneth Beauchemin, an economist with forecaster Global Insight in Lexington, Mass.

"When people start expecting inflation to grow, employees demand higher wages and businesses hike prices," he said. "Inflation begins to feed on itself, which soon distorts investment choices, erodes the buying power of people on fixed incomes and disrupts economic decision-making everywhere."

Wall Street economists roundly criticized the Bernanke Fed Tuesday for not cutting interest rates more aggressively. Its quarter-point rate cut disappointed investors, who promptly dumped stocks and the Dow Jones industrial average plunged almost 300 points.

But the Fed's job isn't to prop up stock prices. Rather, it's to promote steady growth and stable prices. The new inflation data suggest that Wall Street was wrong and Bernanke was right.

The Fed soon may face stagnant economic growth and rising inflation at the same time, a circumstance called stagflation. It haunted the 1970s, but back then growth was slow while inflation ran in double digits. No one forecasts double-digit inflation.

"My feeling is this inflation problem has been much overblown," said Lyle Gramley, a Fed governor from 1980 to 1985, when the Fed tamed runaway inflation. He isn't worried about inflation gathering steam.

The job market isn't so tight that it's driving up wages, he noted, and rising energy prices aren't being passed through the industrial supply chain as higher prices. Cautious spending by consumers, Gramley added, also may dampen inflation.

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