September 3, 2004


Rate Hikes: Enough Already!: Tightening monetary policy to fight inflation seemed like a good idea six months ago -- but not now, when hiring and growth are slowing (Christopher Farrell, 9/02/04, Business Week)

Today, despite oil bouncing nearing $50 a barrel, the core inflation data (that is, minus the volatile energy and food components) is coming in at a remarkably tame pace. For instance, the core personal consumption expenditure deflator (PCE) rose by a mere 0.1% in July, following average monthly gains of nearly 0.2% since the beginning of the year. The core CPI also gained a mere 0.1% after months of 0.2% increases.

The producer price index? That inflation gauge has registered down in recent months. Bond yields have tumbled lower. Indeed, in a twist that has stunned the sagest of forecasters, bonds have substantially outperformed stocks so far this year, with the Lehman Brothers U.S. Treasury index hitting a total return of 2.2%, vs. a -4.2% return in the Standard & Poor's 500-stock index.

The bottom line: Inflation isn't coming back anytime soon. The Fed will probably hike its benchmark interest rate by a quarter point, to 1.75%, during its next monetary policymaking meeting in late September. But with the core PCE rate running at 1.5% year-over-year and the core CPI at 1.8% -- both well within the comfort zone of America's central bank and Wall Street before oil-induced visions of inflation past -- the time for the Fed to end its tightening cycle is near.

Tightening was a very bad idea then, though justifiable to steady folks who don't understand the economic reality of the past twenty years, that looks even worse now.

Posted by Orrin Judd at September 3, 2004 8:51 AM

I have never understood the need to raise rates until inflation appears on the horizon. It is almost as if the Fed sees its job as strangling recovery in its cradle. Why not just keeping cutting until you get a real sustained recovery and then, if inflation actually appears, deal with it.

Posted by: Bart at September 3, 2004 10:49 AM

Because their real role is psychological and their vigilant pose is worthwhile--they just need not to take it seriously.

Posted by: oj at September 3, 2004 10:55 AM

We have reached the point in the cycle where raising rates will help by strengthening the Dollar, reducing the price of oil, lowering insurance rates and other secondary effects.

Posted by: Robert Schwartz at September 3, 2004 11:06 AM

If oil is priced in dollars, all a raise in the dollar does in give the desert bandits more Euros.

If the dollar is raised vs other world currencies, then our goods become more expensive overseas causing other nations to buy fewer of them, how does this help the recovery? It will also be cheaper to hire foreign workers, thus accelerating outsourcing.

Insurance rates, you may have a point as so much of that is based on European and Asian money, Allianz is the largest reinsurer in the world, even bigger than Lloyds.

Posted by: Bart at September 3, 2004 11:16 AM

I've been thinking about Orrin's contention that there is no inflation. Here's what I found:

I bought a house in 1970. I bought the house I live in now in 1990. It was four times as big and cost 12 times as much. If I had to buy it over again today, it would cost 31 times as much as the 1970 house.

One of the next big expenses people have is an auto. Direct comparisons are not easy, because I've never bought a new car. But if I had bought one in 1970, and another today, today's car would be about 3 times as good and cost 9 times as much.

Gasoline, another significant expense, was better then than now but now it costs 11 times what it did then.

College tuition is, after a house, probably the biggest expense for most people. I went to Cow College, and my son also went to Cow College, though not the same one. His tuition was 25 times higher than what I paid.

The computer I use cost me, along with software, $620. If I had wanted the same computing power in 1968, it would have cost me around $3 million.

But, of course, I don't compute anything, I just use it to write. In 1970, I wrote with a 40-year-old Remington typewriter, which I bought for $10 (and still have; it works fine).

Over the period 1970-2004, my income in dollars has increased about 12 times.

So there has been inflation, and the biggest component, by far, has been land. Not surprising when there are about twice as many people using it.

Posted by: Harry Eagar at September 3, 2004 1:52 PM


You believe far less in science than I do.

Posted by: oj at September 3, 2004 1:57 PM

I understand the money illusion.

They used to make Bates Floaters in your neighborhood. Get back to me with a price quote.

Posted by: Harry Eagar at September 3, 2004 7:08 PM

For a workboot? Two pair for $18 at K-Mart.

Posted by: oj at September 3, 2004 7:37 PM

Not the same quality.

In 1970, I had fresh milk delivered to my back door twice a week for about $3.

How much do you suppose I'd have to offer today?

Corn has deflated. Having a baby has inflated.

Is it a wash? Hard to say.

Posted by: Harry Eagar at September 4, 2004 3:12 PM

A current auto is only 3 times as good (as 1970)? You must be buying KIAs or Escorts or small Chevys. Almost everything else is at least 4 or 5 times better (just like the tires, radios, batteries, etc.).

Posted by: jim hamlen at September 6, 2004 7:03 PM