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Wednesday, August 09, 2006

Today's articles.

At National Review, John Tamny examines Treasury Secretary Paulson. has Gary North asking, "Inflation or Deflation in 2007?"

And, the Wall Street Journal attacks the Phillips Curve but argues for further rate increases:

9 August 2006
The Wall Street Journal

A Pause That Digresses

The Federal Reserve has seemed unsure how to proceed on monetary policy for several months, and yesterday it proved it. The Fed's Open Market Committee decided not to raise interest rates again -- not because inflation is contained but because it says the economy is slowing.

Uh, oh. Here we go again, back to the era of the Phillips curve, the economic theory that postulates a trade-off between inflation and unemployment....

In its statement, the Fed conceded that "readings on core inflation have been elevated in recent months," and that this may continue. However, the Fed is guessing that "inflation pressures seem likely to moderate over time," thanks to previous monetary tightening "and other factors restraining aggregate demand." That last bit is the Phillips curve giveaway, suggesting that slower economic growth, such as in the housing market, will reduce inflation along with it.

Let's hope Mr. Bernanke is right about the future direction of prices. But as we all learned the hard way in the 1970s, inflation can increase even when growth slows if the Fed has printed too much money and pricing pressures continue to pass through the economy.

And yesterday's data for second-quarter productivity and labor costs were far from reassuring on that score. Nonfarm business productivity growth slowed to 1.1% at an annual rate, even as hourly compensation (up 5.4%) and unit labor costs (plus 4.2%) climbed sharply. Including upward revisions for previous periods, unit labor costs are now 3.2% higher than a year ago; that's the fastest rate of increase since 2000 when monetary policy was considerably tighter than it is now. When labor costs outstrip productivity gains by that much, it's called inflation.

Perhaps all of this is what Richmond Fed President Jeffrey Lacker was looking at as he cast a dissenting vote yesterday in favor of raising the Fed funds rate (now at 5.25%) another 25 basis points. Come next month, Mr. Lacker will look like a prophet if Mr. Bernanke is confronted with further price increases that force the Fed to resume tightening. This may also explain yesterday's sullen reaction in financial markets to the Fed's "pause," as stocks fell on the news. Typically stocks rally at the end of the Fed's rate-rising cycle, but investors don't seem to be convinced that the Fed is really done.

The larger context here is that the Fed is struggling to make up for its easy-money blunders of 2004 and 2005 without tipping the economy into recession. Like much of the rest of the economic establishment, the Fed underestimated the economy's strength in the wake of the Bush tax cuts of 2003. It kept money too easy for too long, and the inflationary pressures it created are only now showing up with a vengeance in the consumer price and labor cost indices.

While this was mainly Alan Greenspan's last hurrah, Mr. Bernanke was along for part of that ride as a member of the Open Market Committee. The Fed's mistake then has made his job that much more difficult now. Mr. Bernanke no doubt hopes that yesterday's pause is one that refreshes; we fear it has only postponed the ultimate day of reckoning.


Blogger Dick Fox said...

Tamney misses the tax impact on production, that businesses will use money more effectively than government, so he actually misses the supply side. His observation that lower taxes will make people work harder is much like Keynes saying that increasing consumption will increase supply.

By ignoring gold North misses the real inflation that has been going on for the past couple of years. His definition of inflation is a backward looking index.

Does anyone at the WSJ remember classical economics? A slowing economy does not necessarily mean that employment is declining, though increased unemployment is a signal of the decline. Raising interest rates does not reduce liquidity as Ed Rombach has so clearly demonstrated, but raising interest rates does restrict business investment and forces business to be more conservative.

1:52 PM  
Blogger ed hanson said...

I always think it is prudent to link the actual words, when posting a article about them.

Remarks Prepared for Delivery
by Treasury Secretary Henry M. Paulson
At Columbia University

8:15 AM  
Blogger Dick Fox said...


"And addressing issues of wage growth and uneven income distribution."

Early in Paulson's address he invokes the name of Alexander Hamilton but I believe that Hamilton is spinning in his grave that a Treasury Secretary would make "income distribution" one of Treasury's primary concerns. Marx has become engrained in the world's psyche.

7:01 AM  

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