Central bank authorities should not give in to demands for higher interest rates:
A Cross of Rubber, by Paul Krugman, Commentary, NY Times: Last Saturday, reported The Financial Times, some of the world’s most powerful financial executives were going to hold a private meeting with finance ministers in Davos... The principal demand of the executives ... would be that governments “stop banker-bashing.” Apparently bailing bankers out after they precipitated the worst slump since the Great Depression isn’t enough — politicians have to stop hurting their feelings, too.
But the bankers also had a more substantive demand: they want higher interest rates ... because they say that low rates are feeding inflation. And what worries me is the possibility that policy makers might actually take their advice.
To understand the issues, you need to know that we’re in the midst of ... a “two speed” recovery, in which some countries are speeding ahead, but ... advanced nations — the United States, Europe, Japan — have barely begun to recover. ... To raise interest rates under these conditions would be to undermine any chance of doing better; it would mean, in effect, accepting mass unemployment as a permanent fact of life.
What about inflation? High unemployment has kept a lid on the measures of inflation that usually guide policy. ... But food and energy prices — and commodity prices in general — have ... been rising lately. Corn and wheat prices rose around 50 percent last year; copper, cotton and rubber prices have been setting new records. What’s that about?
The answer, mainly, is growth in emerging markets ... — China in particular — ... has created ... sharply rising global demand for raw materials. Bad weather ... has also played a role in driving up food prices.
The question is, what bearing should all of this have on policy at the Federal Reserve and the European Central Bank? First of all, inflation in China is China’s problem, not ours. ... Neither China nor anyone else has the right to demand that America strangle its nascent economic recovery just because Chinese exporters want to keep the renminbi undervalued.
What about commodity prices? The Fed normally focuses on “core” inflation, which excludes food and energy... And this focus has served the Fed well in the past. ... It’s hard to see why the Fed should behave differently this time...
So why the demand for higher rates? Well, bankers have a long history of getting fixated on commodity prices. Traditionally, that meant insisting that any rise in the price of gold would mean the end of Western civilization. These days it means demanding that interest rates be raised because the prices of copper, rubber, cotton and tin have gone up, even though underlying inflation is on the decline.
Ben Bernanke clearly understands that raising rates now would be a huge mistake. But Jean-Claude Trichet, his European counterpart, is making hawkish noises — and both the Fed and the European Central Bank are under a lot of external pressure to do the wrong thing.
They need to resist this pressure. Yes, commodity prices are up — but that’s no reason to perpetuate mass unemployment. To paraphrase William Jennings Bryan, we must not crucify our economies upon a cross of rubber.