Friday, February 29, 2008

Fodder from the Fed

So according to his testimony before Congress, Ben Bernanke seems to think that inflation -- currently greater than it's been for twenty-five years -- will somehow peter out in just a little while. He didn't say how that was going to happen, of course. Will demand for oil by China and India miraculously contract so as to reduce the price of a barrel of crude? Will agribusiness stop growing corn for highly profitable subsidized ethanol, put those fields back into wheat and soybean production, and bring down the price of food? Will the dollar suddenly start getting stronger, bringing down the price of imports?

I don't think so -- but I'm not a world-class economist and Chairman of the Federal Reserve Board. On the other hand, unlike Bernanke, I don't have to worry about my words having a chilling effect on the markets or on consumer confidence. Hardly anybody reads this blog, so I'm free to say what I believe without worrying about consequences.

Bernanke strongly suggested that we can expect more cuts in interest rates. That probably will make Wall Street speculators happy for a while, but the longer-term effects of further cuts are not likely to make the rest of us too happy. Even though the Fed slashed the federal funds rate by almost a third in January, consumer interest rates haven't declined at all. Some variable rate mortgages will reset at lower rates than they might have otherwise, but the rates for new fixed rate mortgages are still drifting upwards -- for the smaller numbers of families who actually can get new mortgages. Credit card rates are just as usurious as they were before the Fed actions.

In other words, the January rate cuts have done nothing to increase consumer spending, and so have done nothing to stimulate the economy. The main effect of further rate cuts by the Fed will be to further weaken the dollar -- and, by definition, a drop in the value of your money is inflation.

Now that the rest of the country has caught up with me and started talking about stagflation, lots of people (including Bernanke) are desperately denying the possibility that it ever could rear its dreaded head again. Of course, there still are plenty of people denying that we're in a recession too, and for very similar reasons. Formally, a recession is defined as two consecutive quarters of negative growth, so we won't officially know if we're in a recession now until the figures for both this quarter and the next are in, sometime around the end of August.

Clearly, if there's no recession, there can't be stagflation -- and anyway, many of the naysayers maintain, you have to have both economic stagnation and inflation for years before you can properly use the term stagflation.

Big deal. Call it what you will, we'll still have to contend with economic contraction, higher unemployment, and inflation at the same time. The Fed isn't very good at doing that, because it can't raise interest rates to counteract inflation at the same time it cuts them to counteract recession.

Dammit, we're going to have to look to Congress again! I'll describe some of the useful things Congress won't do in a later post.

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