The Balance of Risks is Tilted Toward Inflation

After today's negative report on producer prices, Steven Kyle at Angry Bear asks:

So, if the Fed raises rates to keep inflation in check then they will be exacerbating the housing slump which ... is thought by many ... to be the likeliest candidate for leading the economy into a recession.... So what will the Fed do? Worry more about growth or worry more about inflation?

Dallas Fed president Richard Fisher (who is generally hawkish) has an answer. Inflation is the biggest worry:

A Year-End Wrap-Up of the Economy and a Peek Ahead, by Richard W. Fisher, Dallas Fed President: ...[O]one of the wittiest of the Federal Reserve’s economists, David Stockton, told [this tale] last week. It seems a bachelor who thought himself in tip-top physical form was called in by his doctor. “My friend,” the doctor said, “I have just read your lab tests from your physical, and I have very bad news. You have a horrible disease for which there is no known medical cure. I suggest that you marry an economist and move to Arkansas.”

“Geez, that’s awful,” the man said. “Are you telling me that settling down with an economist in Arkansas will help me live longer?”

“No,” the doctor said, “but it will seem longer.”

And the economic outlook?:

...Here is the bottom line. The economy is sending mixed signals. The bad news is that the housing industry is undergoing a sharp correction that may not have run its full course and auto production is more anemic than desirable. The not-so-good news is that expansion of manufacturing activity and things made in factories has shown signs of slowing, but—and this is important—from high levels of activity. ...

The good news is that the dampening effect of the housing and auto sectors and the slowdown in manufacturing activity have been offset by continued growth in the service sector. ...

On the inflation front, the good news is inflationary pressures appear to have reached a stasis, despite the labor shortages in certain sectors—particularly in chemicals and petroleum industries and in functions requiring skilled and semiskilled workers. The bad news is that the stasis is at too high a level for party poopers like me who will have no choice but to advocate tightening monetary policy further if inflation does not ratchet downward. ...

Given all of this, I would have to say that the risk of unacceptably high inflation still outweighs the risk of substandard economic growth. ...

[Note: Speaking of Angry Bear, former ones anyway, Kash at The Street Light and Menzie Chinn at econbrowser have a new WSJ econoblog on exchange rates. If you haven's seen it yet, it's here.]

Comments

[pgl]

Menzie and Kash were good at the econoblog but they really didn't touch on the Tinbergen Condition argument put up on Friday by the new Angrybear - Steve Kyle. So this old Angrybear decided to do a follow-up on their econoblog starting up where Steve left off.

[Bruce Wilder]

"the stasis is at too high a level for party poopers like me"

And, what is that level, pray tell?

Last, I looked (10 seconds ago) the CPI hadn't budged and wholesale prices for the year were under 2%.

OK, that wholesale number for November was scary, but what did you expect? (When the oil industry depresses prices to win an election for the gipper, it expects its money's worth, and if it doesn't get it, someone has to pay, and it's you and me that payz.)

If Fischer knew his business, he would worry that inflation might dip below 2%, not that it might rise above 2%. He's going to risk a recession to hold inflation under 2%. That's not just ridiculous, it ought to be criminal.

[anne]

Notice what did not happen today with a supposed scary inflation number; long and intermediate term bond indexs and interest rates barely budged. Investors are confident inflation will be no problem. International and domestic investment markets are calm and conservatively bent but elevated.

[maria]

Can anyone furnish a chart or website that tracks the relationship between the PPI and the CPI over time?

[Mark Thoma]

maria:

See here.

Mark

[Movie Guy]

Bruce Wilder - If Fischer knew his business, he would worry that inflation might dip below 2%, not that it might rise above 2%. He's going to risk a recession to hold inflation under 2%. That's not just ridiculous, it ought to be criminal.

If Richard Fisher knew his business?

With all due respect, Bruce, how much do you know about Richard? I ask in a friendly spirit.

Did you happen to read his entire remarks? He discussed the Dallas Fed Trimmed Mean PCE and the summary results of that analysis.

I might not have agreed with Richard on this one at first blush, but I do know that he is reviewing far more economic than I have access to on any given day, month, or year. It may be available in some measure but I can't pull all of it together and analyze it properly. And I have one screamer of a computer that can crunch data files.

This is what Fed Governor Richard Fisher said about inflation:

"On the inflation front, the good news is inflationary pressures appear to have reached a stasis, despite the labor shortages in certain sectors—particularly in chemicals and petroleum industries and in functions requiring skilled and semiskilled workers. The bad news is that the stasis is at too high a level for party poopers like me who will have no choice but to advocate tightening monetary policy further if inflation does not ratchet downward."

"At the Dallas Fed, we prefer to look at inflation through a prism called the Trimmed Mean PCE. I won’t bore you with the details of how it works, but I’ll tell you this: We had some encouraging news in September when the Trimmed Mean showed inflation had dropped down to 1.6 percent. Unfortunately, it rose back to 2.6 percent in October, close to where it had been nestling before the September drop. This uptick was partially caused by costs in that pesky service sector: medical services."

"When we analyzed all the items in the personal consumption expenditure basket from medical costs to the costs of restaurant meals, we noticed that the median inflation rate was running at 4 percent and that over 30 percent of the items in the basket had prices that were increasing at a rate of over 5 percent. Now, this was for October. The November numbers come out on Friday, so we will have to wait until then to see the latest movements. While we at the Dallas Fed are hopeful that the measures taken to raise the federal funds rate from 1 percent to 5.25 percent will quell inflation and, very important, expectations about future inflation, we cannot yet say with conviction that we have turned the corner and have this problem fully contained."

"Given all of this, I would have to say that the risk of unacceptably high inflation still outweighs the risk of substandard economic growth."

"Nonetheless, I think we are ending the year in pretty good shape. I do not agree with pundits who argue about whether we can engineer a “soft landing.” “Landing” implies stopping. I prefer to say that the Fed’s job is to provide the monetary conditions necessary to pilot our economy at a comfortable cruising altitude and speed while preventing the engine from overheating with inflation. As we look to 2007, I consider this objective to be within reach. And that, good Rotarians, would be far from a dismal outcome. You needn’t marry an economist and move to Arkansas. You can stay right here in Longview and thrive."

[save_the_rustbelt]

Do these economists realize that when they cause a recession real people are hurt?

Nah, they only deal in statistics.

Given the retail gasoline roller coaster, it seems difficult to make any firm conclusions about inflation.

[Bruce Wilder]

"With all due respect, Bruce, how much do you know about Richard? I ask in a friendly spirit."

I know that on the subject of inflation, he's inclined to be hysterical.