Monday, April 21, 2008

Screech of the Inflation Hawks

A good resource for monetary policy tea leaf reading is the Wall Street Journal's Real Time Economics Blog, which does yeoman work tracking the utterances of Fed officials. RTE reported Thursday that some of the regional Fed Presidents are hinting that they have had enough of the rate cuts:
Federal Reserve Bank of Dallas President Richard Fisher has for several months now been among the central bank’s outspoken critics of the way the Fed conducts monetary policy. He stuck to his guns Thursday, saying he had a “strong reluctance” to cutting rates again. “The answer, to be curt, is not to compound the bad by repeating the oft-prescribed remedy of inflating our way out of our predicament with a wing-and-a-prayer promise that it can always be reined in later,” Fisher said, speaking at an event in Chicago. He reiterated his belief the Fed’s best tools to combat the current threat to the economy rests in its expanded or newly launched initiatives aimed at providing liquidity to financial markets. Fisher is currently a voting member of the interest rate setting Federal Open Market Committee, and he formally opposed the Fed’s last two rate cuts.

Another official has also suggested he’d be uncomfortable with a move to lower interest rates further. Federal Reserve Bank of Richmond President Jeffery Lacker told reporters at a conference on credit held by his bank in Charlotte, N.C., Thursday that “inflation is a problem now. It’s too high.” The official, who isn’t a voter this year, leaned against the dominant view among policy makers, which is that moderating, if not contracting, economic activity, will lower price pressures. “I’d be uncomfortable just waiting for economic slack to bring [inflation] down.”
On Friday, Philadelphia Fed President Charles Plosser also expressed concern about inflation.

How concerned one is about inflation depends, in part, on the measure chosen (or perhaps the choice of measure depends on one's concern).
The most-watched measure of inflation, the rate of change of the Consumer Price Index (CPI, in green), has risen above 4% - some ammunition for the inflation hawks in the upcoming FOMC meeting. However, the CPI is believed to slightly overstate inflation - an alternative is to use the deflator for personal consumption expenditure (i.e. the deflator for the C part of GDP, in red) - which makes the inflation picture less alarming, but only slightly so. If we take out the prices of food and energy and look at "core" inflation (blue), then the inflation picture doesn't look so bad.

The FOMC's next scheduled meeting is April 29-30. The Cleveland Fed calculates the probabilities of different outcomes of the meeting implied by prices of options traded on the Chicago Board of Trade. The markets are betting that the inflation hawks will not have the upper hand in the committee; they forecast a cut in the target, to 2.0% (or, possibly 1.75%):

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