Caroline Baum is a columnist for Bloomberg News. With the quadrennial presidential election behind...
Caroline Baum is a columnist for Bloomberg News.
With the quadrennial presidential election behind us and the permanent political campaign in the US at its cycle low, policy is becoming paramount again.
Disturbing the Peace
The Fed is aiming to turn the economy into the wind in an effort not so much to slow growth but to restore interest rates to a non-inflationary setting.
If you block out the peripheral noise in the minutes from the 14 December meeting, the central message comes through loud and clear. Even with the increase in the funds rate to 2.25% last month, "the current level of the real funds rate target remained below the level it most likely would need to reach to keep inflation stable and output at its potential," the Fed said. Greenspan's challenge is to wean the economy from its dependence on abnormally low interest rates without bursting any of the potential asset bubbles — undiagnosable in real time, according to him — in his final season as orchestra conductor. Inflation, for one. Accelerating inflation could spoil the party, raising inflation expectations and interest rates and prompting the Fed to act more aggressively to head it off.
Joachim Fels, senior economist at Morgan Stanley in London, said he was struck by the "inflation complacency" among investors at the firm's annual MacroVision conference last week.
Unlike the invited guests, Fels said the inflation risks "are skewed to the upside due to slowing productivity growth in the US, a weaker dollar and higher commodity prices, and expansionary monetary policy."
If his forecast for a bout of stagflation – slower growth and higher inflation – is correct, it would cause the yield curve to steepen, he said, confounding the actual and expected flattening trend.
Doug Lee, president of economics from Washington, an economic consulting firm based in Potomac, Maryland, has identified some "disturbing underlying patterns" in the consumer price index, which rose 3.3% in 2004, compared with a 1.9% rise in 2003. The core CPI, which excludes food and energy, rose 2.2% last year compared with a 1.1% increase in the preceding year.
To what do we owe the tame 2% annualised increase in the core CPI in the fourth quarter? Why, our old friend, owners equivalent rent: the largest single component of the CPI — 23.4% of the CPI and almost 29.8% of the core index — and one that imputes a rental value to owner-occupied homes based on a survey of rental units.
No Prices = Bad Data
The theory of measuring the flow of services from a home instead of the price of the asset makes perfect sense. After all, the Bureau of Labor Statistics is attempting to measure the price change of goods and services consumed, not of assets purchased for investment.
"In theory, it's nice," Lee said. "As a practical matter, you can't do it. There are no market-based data, no prices to measure, so the quality of the data aren't very good." While the CPI's "top line isn't doing anything exciting, the truth is everything but housing is going up," Lee said.
For the Fed, the booming housing market carries a whiff of "excessive risk-taking." To the rest of us, it smells like inflation.
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