Friday, December 14, 2007

Is the Fed fighting the wrong battle?

I am just an Okie outsider, not privy to the forecasts and deliberations of the FOMC. But I do know these things (1) Output is still growing and unemployment is not rising. (2) Inflation is rising (3) The last time our monetary authority accomodated energy price increases in a big way didn't work out so well.

On point (1): Unemployment was steady at 4.7% last month and new jobs went up by 94,000. Third quarter real GDP growth was above 4% and productivity rose by 6.3% in that quarter. Even industrial production rebounded from its October fall to post a November gain.

On point (2) CPI inflation was .8% in November and is running at over 4% for the last 12 months and over 5% (annualized) for the last three months. Even "core" inflation is rising and rising faster than predicted. The real return on 10 year t-bonds is slightly negative now.

On point (3) of course I am refering to the stagflating 70s.

So either the Fed is making mistakes, or is being politically pressured into this policy path knowing it's probably a mistake, or the Fed foresees something really really bad in the near future that it doesn't want to talk about publically.

I am not sure which of these three scenarios I hope is the correct one.

Update: This well reasoned gentleman has a slightly different view of the situation.


John Thacker said...

My understanding is that stagflation began somewhat before the oil price jump. Oil prices took one enormous doubling around November 1973, and then were pretty steady after that until 1979 and the Iranian revolution/OPEC production cuts.

However, I would argue that stagflation was already starting to be an issue beforehand, such as when Nixon's wage and price controls were implemented in late 1971.

Anonymous said...

My personal prediction is #3, "...the Fed foresees something really really bad...". I think the really really bad thing (or maybe just pretty bad) is going to be driven by credit problems beyond mortgages, ie. construction loans, installment loans, credit cards, etc. If this has the effect of decreasing consumption (C) and investment (I), then of course GDP growth would slow as well.

Anonymous said...

A serious question: why be worried about negative real yields on Treasuries and rising inflation when 1) the owners of Tresuries are typically older more timid folks who are collecting social secuity benfits that have been indexed to wages and 2) foreigners who have little choice (other than equities) to continue what they view as their priorities by ensuring export levels?

Angus said...

I mentioned the negative return only to point out that policy is already pretty loose.

As to rising inflation, it is an interesting question as to why citizens/voters react so negatively to inflation when economic theory shows little negative effects.

For me rising inflation is bad because that is what the Fed is NOT supposed to let happen and the higher it gets the worse of an economic slowdown that will follow when the Fed decides to do something about it. Getting inflation down in the 1980s was extremely economically painful.

Angus said...

John you can check the "misery index" (sum of inflation + unemployment) here:

it averaged around 10 under Nixon, rose to above 15 in the Ford years, and peaked in 1979 at over 20 under James Earl Carter

John Thacker said...


Yes, but it was also clearly higher under Nixon than under Johnson as well-- and had been trending up during Johnson's second term as well. It's still my opinion that there was a rise in the general price level under Nixon before the oil shock came, and that the inflation of stagflation was much more broadly based than a simple relative rise in energy prices.

There's no doubt that the oil shock made inflation worse, but I think it's a bit much to point to it alone as the cause of stagflation.