Inflation | - Part 4

Why the Fed May Again Fail

We might be hearing a little less talk from the Federal Reserve about how much “slack” there is in the economy (Fedspeak for the “output gap”, or the difference between real and potential growth) after a new report by Commerzbank as detailed in this Bloomberg story.

The Federal Reserve, Bank of England and European Central Bank have started using the level of spare capacity in their economies as a way to foretell when they will start reversing easy monetary policies. The more capacity, the bigger the output gap between actual and potential economic growth and the longer officials can keep interest rates low because price pressures will be sluggish.

Bloomberg“While this sounds plausible, past experience suggests that central banks tend to hike rates too slowly, with corresponding risks for price inflation,” Christoph Balz and Bernd Weidensteiner, economists at Commerzbank AG in Frankfurt, said in a March 21 report.

The problem is that output gaps are hard to estimate and better done in hindsight. To demonstrate that, the Commerzbank economists looked at what the Fed would have estimated for the output gap in the early 1970s, given the data they had available from the prior three decades.

The initial impression was of an output gap of minus 1 percent for 1974, which would have encouraged the U.S. central bank to be “moderately expansionary,” said the report.

In reality, the economy was later shown to have been slightly over-stretched in 1974. Repeating the exercise for 1983, the output gap the Fed would have calculated at the time was minus 1 percent, versus the minus 4 percent it proved to be.

“A more restrictive policy would have been appropriate in 1974, but in 1983 a more expansionary policy was required,” said Commerzbank. “This demonstrates the uncertainty when monetary policy conclusions are drawn from the current data set.”

With the Fed’s new lines of communication aimed at damping expectations of rate hikes, the risk is the Fed “will again probably raise rates too late and too cautiously,” said the economists. This time the “greater danger” may be that loose monetary policy fans inflation in asset prices.

This idea that, it doesn’t matter how economic growth arrived at a particular level (e.g., in 2007 after the biggest credit bubble since the 1930s) and that you should somehow gauge future economic growth against past growth (regardless of how artificial it was) – this is one one of the stupidest things that economists have ever come up with.

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Beef, Milk Prices Surge

Though the government’s official measure of inflation showed only a modest overall increase last month when it was released earlier in the week, milk futures reportedly jumped to a record high on Monday and beef prices have also recently surged as shown in the graphic below from this item at the Wall Street Journal’s economics blog.

This WSJ story ($) in today’s paper details how drought and rising exports have contributed to the recent increase in food prices that, last month, jumped 0.4 percent according to the Labor Department.

I’ve likened inflation concerns in recent years (particularly since the Federal Reserve began its money printing extravaganza in 2008) to “the boy who cried wolf” and, just in the last few weeks, a growing (albeit still pretty small) number of boys are again crying wolf.

Importantly, in the parable, the wolf eventually comes…

Me Again

Another interview with Cory over at the Korelin Economics Report is now available.

This is from last Friday, as gold was finishing out a pretty impressive week of gains due largely to geopolitical concerns about Ukraine and Russia. We talked mostly about the nascent threat of inflation here in the U.S. and how that could affect precious metals.

The .mp3 file is again available here at the blog – just click on the image to the right – or you can go directly to this page over at KER.

That inflation is a threat today is certainly the minority view. I’ve likened what has happened in recent years – since the Fed started printing money with abandon, only to see the government’s official measure of inflation decline – to “the boy who cried wolf” and the only question now is whether the wolf will ever show up.

The combination of demographics and Obamacare have raised the possibility that we may see some wage pressure in the labor market and, combined with what appears to be a resurgence in commodity prices, rising consumer prices could surprise a lot of people this year and precious metals would surely benefit.

[To access commentary that Tim only shares with subscribers, join Iacono Research.]

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Inflation Tame, Housing Starts Mixed

The Labor Department reported that U.S. consumer prices rose 0.1 percent in February for the second straight month and that the annual rate of inflation dropped from 1.6 percent in January to just 1.1 percent last month, one of the lowest rates since 2009.

Falling energy prices were the primary reason for the overall price decline as this index fell 0.5 percent after a gain of 0.6 percent the month before, but food prices rose in February, up 0.4 percent after gains of 0.2 percent and 0.1 percent in prior months.

Also this morning, the Commerce Department reported(.pdf) that housing starts came in just below expectations, but permits for new construction (a key leading indicator for the home building industry) surged in what was a hopeful sign for the housing market this year.

Housing starts fell from an annual rate of 909,000 in January to 907,000 in February and permits jumped 7.7 percent to a rate of 1.018 million after dropping 4.6 percent in January.

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