Chicago Fed President Moskow Says Rates Must Increase to Ease Inflationary Pressure

Michael Moskow, president of the Chicago Fed,  says rates need to increase to head off inflationary pressure even after Hurricane Katrina.  In other news today, unit labor costs rose and productivity fell as second data were revised contributing further to inflation worries.  From Bloomberg:

Moskow Says Rising Prices Require 'Appropriate' Fed Response, Bloomberg:  Rising inflation pressures need to be addressed with ''appropriate'' increases in interest rates, even though Hurricane Katrina may temporarily slow the rate of growth the rest of this year, Federal Reserve Bank of Chicago President Michael Moskow said.

''I'm concerned about core inflation running at the upper end of the range that I feel is consistent with price stability,'' Moskow said ... ''Even without an increase in inflation expectations, it will take appropriate monetary policy to keep inflation well contained.'' Moskow is the second voting member of the Federal Open Market Committee who has suggested that interest rates are likely to rise after Hurricane Katrina if inflation pressures continue to build. Philadelphia Fed president Anthony Santomero said Aug. 31 that a ''measured pace'' of rate increases ``will continue to be appropriate.'' … An assessment of Katrina's impact on the national economy will involve ''a number of judgment calls'' by the Fed, Moskow said. ''It is very difficult to say how the national economy will be affected,'' he added. Katrina is clearly worse than other natural disasters, such as 1992's ... ''The impact on the economy will depend on the extent of the damage to the energy refining and distribution systems, shipping infrastructure, and other critical components that affect the national economy,'' Moskow said. ''An important aspect of this is the time dimension -- how long it will take to make the repairs needed to resume operations.'' Economic effects ''can be mitigated by how businesses outside of the area adapt to the disruptions,'' he added. Economic data on such adaptations is lacking … ''Rising oil prices may reduce economic growth,'' Moskow said. They could also feed through and raise prices of non-energy products and services, Moskow said. ''So there is also a risk on the inflation front, and the risk is higher now than it was a year ago,'' Moskow said. ''Because the economy is running nearer to potential, unfavorable cost developments are more likely to pass through to core inflation.'' … Moskow … has never dissented against the FOMC majority in policy votes.

Interesting.  Janet Yellen from the San Francisco Fed speaks tomorrow.

[Update:  Yellen's comments.]

Comments

[anne]

Well, there is going to be a massive flow of funds to the Gulf Coast. There is also coming the energy and highway spending. So the fiscal stimulus may be enough to insure fair growth no matter continued Federal Reserve interest rate increases.

[anne]

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[anne]

A question that will be long in deciding is whether New Orleans will recover in population, and will the population mix be anywhere near what it was?

[knzn]

Interestingly, all the analyses I see of the Fed’s likely response to Katrina seem to be from a Keynesian demand-management perspective: either the Fed will raise interest rates in order to reduce demand and prevent inflation, or the Fed will forego raising rates in order to increase demand and cushion the slowdown. While that is the perspective I would normally take, I’m surprised that nobody has approached this from the more classical perspective of the supply and demand for loanable funds.

Suppose that the Fed’s objective, rather than to manage demand per se, is to find the equilibrium interest rate that should come out of the market for loanable funds. I expect some people at the Fed actually believe in this approach, and most of those who don’t still regard it as a useful exercise. Under some theories, the two approaches should come to the same result, and in general, when they come to very different conclusions, there should be a sense that something screwy is going on.

So what effect will Katrina have on the supply of loanable funds? First look at the government: obviously, the supply there goes down; the government is borrowing more and draining more funds from the market. Now look at the public: at least from those directly affected by the storm, the supply of funds is likely to go down; many of them were receiving paychecks and no longer are. Now look at the foreign sector: problems with a major shipping route make it more difficult to import, so fewer dollars will flow abroad, and thus fewer will come back as loanable funds. (Exports will also fall, but given that we already have a large trade deficit, the bigger effect is likely to be on imports.) So the supply of loanable funds goes down, rather unambiguously.

What about the demand for loanable funds? That’s something of a wild card. If Kash of Angry Bear is right about the effect on confidence, then the demand for funds will go down. But judging by the stock market, there hasn’t been a clear decline in confidence. On the other side of the picture, the destruction of part of the capital stock might create an incentive to invest in rebuilding (e.g., people who lost houses, particularly those with insurance, may want to rebuild). So the effect on demand for funds seems to be ambiguous. If I had to guess, I’d say it’s pretty close to neutral.

Clearly if you put together reduced supply of funds with neutral demand for funds, you should get higher interest rates.