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Wednesday, October 12, 2005


Edward Hugh

"King cited with approval Fed Governor Don Kohn's comment two weeks ago that “policymakers should be cautious about responding aggressively to estimated movements in economic slack”. Rather than panicking about economic slack, King appears to be more concerned by capacity contraints."

I think King is more motivated by the need to stick-by the Fed than any real domestic issues. Maybe this is why he was citing Don Kohn. Basically if European rates remain low (ECB, Sweden) or come down (UK) this will have a currency effect which will tend to offset the desired outcome on the US CA deficit. Since King will be convinced that the 'imbalance' needs correcting, and that this is the global priority, and that sqeezing the US consumer is the only realistic way to do this, then he is backing Sir Alan. I'm sure all this was discussed in Washinton recently, or put another way, I'm sure Antonio Fazio wasn't the only item on the agenda during table talk :).

One thing people tend to forget is that an oil price hike constitutes what economists call a 'level effect'. That is there is a one-off effect on the level of prices. But if after the hike the price holds - at say around 60 dollars a barrell - and there are few 'secondary effects' then after 12 months this moves out of the year-on-year cpi. So the hike affects the price level on a one-off basis, but not the *rate* of growth of inflation.

"He also stressed that high oil prices limited the ability of the economy to grow without inflation"

Well I buy the limiting the ability to grow story, but we really need some evidence of this on inflation in the UK case. Yesterday's job report showed earnings more-or-less steady on trend. Housing isn't likely to prove too inflationary in the near term either. And we should remember that the UK was struggling from 1998 to 2005 to get up to the desired 2% inflation target. Hardly a pre-occupying inflation record card.

So, if this is the case, and we don't get those horrid second round effects which all the bankers claim they can see just around the corner (yes, its always just around the corner ) then the main effect of $60 oil is on growth not on inflation, which means..... well it doesn't mean you need a general raising of interest rates.

So this then brings us back to housing in the US and Spain, and how Mervyn King with 4.75% rates in the UK burst (hopefully in a benign way, but we still don't know) the bubble.

What I am saying is that Greenspan is targetting housing, and that there is a consensus that the US can't raise rates alone. My gut feeling is that depite all the talk of 'transparency' and 'learning curves' behind closed doors there is a Central Bank view that something has to be done (which doesn't mean that something can be done: if you look at the piece I link to on Afoe by Kotlikoff and co concerning the relative saving and CA positions of the US and China, it is clear that there may be strong demographic reasons why the imbalance may continue for some time to come. The difficulty is that the US might get 'hollowed out' - just like Spain might - while this process continues).

To sell this something to the politicians and the general public you need the 'inflation threat' story, even if - at least ex-US, Spain and Greece - there is relatively little hard data to back up the story.

If you notice even Fukui is being pretty "pro-active" right now too:


Japan's bonds fell and 10-year yields approached their highest since November after central bank Governor Toshihiko Fukui said interest rates will rise from zero percent because of inflation. Japan's seven years of falling consumer prices are close to ending, which means rates ``will eventually head toward positive territory,''

"be cautious about responding aggressively"

C'mon Mervyn, who would have ever thought that another quarter point cut could have been called aggressive (unless, that is Sir Allen's measured pace is extraordinarily aggressive, if so I need a new dictionary). I smell something fishy, the man doth protest too much :).

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