Why The Fed's Cut Won't Spark Inflation

Discussion in 'Wall St. News' started by makloda, Oct 8, 2007.

  1. Housing woes, tighter credit, and a softer labor market should douse it

    Did the Federal Reserve do a good thing or a bad thing? Wall Street and bourses around the world seem to be of two minds since the Fed boldly slashed its target interest rate by a half-point on Sept. 18. The response in several previously frozen markets for short-term financing was extremely positive, and stock investors were jubilant. However, the reaction in longer-term fixed income and commodities markets, especially for gold, has been more circumspect. Investors there have new worries that the Fed just kick-started a round of inflation.

    The concerns seem clear. The price of crude oil is hovering around $80 per barrel, threatening to lift energy costs in coming months. Gold, a traditional inflation hedge, has soared above $700 per ounce and is flirting with a 28-year high. The dollar has fallen to a record low against major currencies, and that is expected to boost import prices. And market-based measures of expected inflation have picked up.

    However, all that does not add up to a deteriorating inflation outlook. What's missing is the economic backdrop against which all this is occurring. The economy is slowing down, as the effects of a new decline in housing and the credit crunch are buffeting consumer and business demand. The labor markets are softening, a process that began before the credit squeeze and one that eases worries that rising labor costs will fuel higher prices. Moreover, inflation outside of energy and food has been falling all year and has shown little evidence that higher production costs for energy and food are being passed along into prices of other products.

    Perhaps most important, a financial shock that results in falling asset prices is never inflationary. It's just the opposite. For example, when the bubble in tech stocks burst in 2000, the U.S. economy flirted with outright deflation; that is, not just lower inflation but falling prices. In 2003 and 2004, prices of consumer goods, excluding energy and food, fell for two consecutive years, something that hadn't happened since the Depression. This time it's home prices that are falling, and the impact is hammering prices of mortgage-related securities.

    THE ECONOMY IS HARDLY in a position to generate a worrisome bout of inflation right now. It managed to grow only 1.9% from the second quarter of 2006 to the second quarter of this year. In coming quarters, as the slump in housing and tighter credit depress demand, the average growth rate is unlikely to accelerate from that clip.

    Significantly, the economy's recent and prospective pace is safely below any accepted estimate of the economy's noninflationary growth limit. Most economists believe that rate is somewhere above 2.5% but below 3%. When an economy grows below that pace for a long period, demand is not strong enough to strain the productive limits of existing labor and production capacity, meaning upward pressure on prices is difficult, if not impossible, to sustain.

    More: http://www.businessweek.com/magazin...p+news_top+news+index_businessweek+exclusives
  2. piezoe


    I agree that this is likely a correct assessment overall. Somewhere buried in these ET forums there is also a claim that the Fed while increasing bank liquidity and lowering the discount and Fed funds rate was apparently selling assets simultaneously. Result: the money supply , on balance, actually decreased.
  3. This article is very off track imo. From what I'm reading, the big buzz is over potential stagflation. Here's a few examples: