Is There Really an Inflation Conundrum?

I don't blog much about economics and there is a reason for that - I find the term "dismal science" a little bit too charitable for the subject. So go easy on me after reading this.

There is this consensus building in the market (God, how I hate that word) that the Federal Reserve is caught between a "rock and a hard place." The Fed wants to raise interest rates to fight inflation expectations that are clearly building in our society. This can be seen in the two charts below. The first is Household inflation expectations, and the second is the adjusted 10-year TIPS-derived expected inflation:





It is unable to fight these inflation expectations by raising rates since the economy is so fragile, and it is thought that any increase in short term rates will crush any incipient recovery in its womb.

But would higher rates actually have that effect? It seems the problem is more availability of credit, not the cost of credit. This can be seen in the results of the latest Senior Loan Officer Opinion Survey on bank lending practices conducted quarterly by the Federal Reserve. The survey reports the percent of lenders who, in this case, have tightened lending standards over the previous three months.

"55 percent of domestic banks—up from about 30 percent in the January survey—reported tightening lending standards on C&I loans to large and middle-market firms over the past three months."

"80 percent of domestic banks and 55 percent of foreign banks—fractions similar to those in the January survey—reported tightening their lending standards on commercial real estate loans over the past three months."

"60 percent of domestic respondents—a somewhat larger fraction than in the January survey—indicated that they had tightened their lending standards on prime mortgages."

An article in the Financial Times Sunday had the quote from a banker "...and the banks are canceling revolvers wherever they can.”

It might be better to raise rates to defend our currency. This would have the dual effect of breaking the upward momentum of Oil as traders will have to find another excuse to push it up. Once Oil starts trading back toward the level it should based on fundamentals, inflation expectations should come down. If gasoline prices follow oil down, then that will free up money for discretionary consumer spending.

Raising rates will have the deleterious effect of hurting those homeowners with adjustable rate mortgage resets, but the opening up of credit markets for them may be a side effect of a stronger dollar.

Comments

[jjc7477]

If it were just a housing issue or just a credit issue or just a commodity issue, maybe it would be easy to answer which direction the Fed should move, if at all. The problem, however, is when you have all three of these PLUS a slowing economy, there truly is no solution. If ever I've felt the world economy stands at the brink, it's now. The myriad of events unfolding worldwide over the past several weeks, especially as the rest of the world's economies have begun to contract along with ours, has taken on the ominous appearance of a ticking time bomb.

[armadillo]

I don't think there is a brink, sure stuff is still overvalued, but after everthing is valued correctly we still have the same stuff we had before so why are we worse off? After everyone get over the fear of stuff going down further we can get back to business. The US can compete we just need to focus on the jobs others can't do, not what they can do cheaper. Oversimplified, maybe, but we need to step back and look at where everyone stands in relation to each other.

[flow5]

There's no such thing as the dismal science. There are just no important research papers on the proper subjects - bank debits, legal reserves, and leakages associated with the savings-investment process.

And raising interest rates in the short-run will cause a larger fall in the exchange value of the dollar in the long-run.

Bankers grant loans when they see an advantage to do so. There has been a macro-economic change in their environment. Everybody else on all of the financial blogs are talking about it.

[bindlepete]

The salvation of the middle class and our broad economy lies in some bitter medicine. This after a binge of consumtive borrowing. Sorry there is no easy way out and deferral until after the Administration is gone - the current strategy - will just make the ultimate correction worse.

Jamm those rates up to the 18 -20% rate level. Collapse some banks and hedge funds, those that were protected by the Bear Sterns transaction - take the bitter medicine and pain of readjustment and give it 5 years to correct.

Pulling the plug on Iraq to cut costs and starting a public works program to re-establish the infrastructure and employ the retuning veterans might also be an alternative. Then reform our transportation structure to racalibrate the airline( trans continental and intercontinental) and return to rail for intercity transport with mag lev for people and steel for freight equipment. Move intra city deliveries to night time via truck, and so on and so on. There is a lot to do and not much time to get it all under way. The chinese are beating our socks off because they can be apolitical and rational in their advances.

[morgan77]

interesting article on inflation and government spending on greenfaucet today-

basic idea is that more government spending (programs or stimulus checks) will just delay the economy's recovery. the author also argues that inflation is today is relatively calm compared to the rates it was increasing at in the first half of the century. check it out:
www.greenfaucet.com/ec...

there are also some funny lifestyle pieces on this site if you're looking for a break

[Reinko]

Another main problem not mentioned in the article above is the giant mountain of debt that the US economy has upon herself:

It is over 50 trillion in direct debt (so not included future obligations for Social Security and so), this debt includes consumer debt, mortgates, HELOC, car loans, State and Federal debt and so on and so on.

Raising just 1% from 2% to 3% will drive interest costs up for most of that 50 trillion of debt. And thus 500 billion US$ in yearly interest costs.....

But there is hope glooming on the horizon: At the Federal Reserve website I found a line of credit that is indeed declining (anyway it looks like it is declining). It is in the g20 file:

www.federalreserve.gov.../

Now we only wait for the rest of the debt to unwind...

[Eric Fox]

flow5...what do you mean by this:

"And raising interest rates in the short-run will cause a larger fall in the exchange value of the dollar in the long-run."