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Tuesday, December 19, 2006

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.]

    Posted by on Tuesday, December 19, 2006 at 04:05 PM in Economics, Inflation, Monetary Policy | Permalink  TrackBack (0)  Comments (8)


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