Democrat From Kentucky

Democrat from Kentucky
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Is the Fed Unnecessarily Scaring Stock Markets? Friday, October 07, 2005

I'm on a regular mailing list for economist Dr. Peter Morici. He's got a huge list of credentials that I won't get in too. I will post his email here. He's got some thoughts on the current financial situation:

Is the Fed Unnecessarily Scaring Stock Markets?

The Wall Street Journal reported this morning that three regional Federal Reserve Banks sent shivers through markets by calling attention to the threat of inflation. These fears are grossly exaggerated, and higher interest rates may cripple the economy.

Regarding inflation, two questions are key.

First, how much of recent energy price increases will work through to final nonenergy goods? How much of that happened and happens in September and October will occur regardless of Fed actions November 1. So far, very little pass through seems to have occurred. The producer price index for final consumer goods, less energy, fell in August. Look at autos. It's not just the Big Three that have been forced to trim prices but also the Japanese nameplates too.

Elsewhere, firms are going to face tough resistance to higher consumer prices. The producer price data indicate large increases in commodities and more moderate increases in semifinished goods and inputs to service providers (e.g., express delivery), but no inflation in final goods and services. Producers have enjoyed very strong productivity increases in recent months, permitting them to absorb somewhat higher material prices, and consumers have little additional cash to spend on higher priced goods (consumer spending was already greater than disposable income in July and August), and gasoline prices are draining their purses. Final goods inflation is what matters, and that seem under control for reasons relating to both supply and demand.

Second, does any pass through of energy prices to nonenergy goods set off a self-perpetuating spiral, or is the current burst, such as it is, a one time event? If it is a one time event, we are going to get the burst of inflation we get, regardless of Fed actions November 1. It's too late to affect those. Moreover, energy prices should recede as oil and gas and refining come back on line in the Gulf, and inflation will abate regardless of what the Fed does. We simply have too much competition in the marketplace, and labor markets show not sign of igniting a wage-price spiral.

The Fed is behaving as if we were in the 1970s, when union contracts would ignite wage-price spirals--not so with an 8 percent private-sector unionization rate. Companies that still index wages to inflation will contract very quickly, as other players in the marketplace eat their lunch.

Longer term, energy prices are going to be determined in global markets, and the Fed can do little about those. If we pumped most of oil we use, oil were in short supply, and we could not import additional supplies only at higher prices, the Fed would face a tradeoff between higher oil prices and growth, and the Fed would have the option of dampening growth to stave off inflation. Those days are long gone, and the Fed simply does not have that choice today.

The Fed is behaving as if it could affect energy prices and it can't. It is correct to worry about inflation but in its thinking, the Fed has its feet planted firmly in the past.

With Katrina and Rita already sapping consumer confidence and consumers having little additional money to accommodate higher gas prices, the economy is going to slow significantly with or without Fed action. Raising interest rates at this juncture only risks throwing the economy into a recession

All the Fed is accomplishing with its rhetoric is to panic the stock market. Will lower equity values help inflation? I think not!

Peter Morici
Robert H.Smith School of Business
University of Maryland
College Park, MD 20742-1815
703 549 4338
cell 703 618 4338


Greenspan is making the same mistake he made back during the first Bush administration. He needs to let the economy ride a little bit. He needs to quit screwing with it too much before it's unrecoverable. Why doesn't he tell Congress something smart like either cut spending or raise taxes.

posted by Stithmeister @ 11:14 PM

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At 10:38 AM, Blogger Cynicus said...
i'm not Doctor Whoozits, with a string of letters after my name. But i'm not paid to pundit either (you get that for free, you poor bastards).

Anyway, New Orleans is still gone, with all that entails. The oil shock may not have made it into the rest of the economy yet, but given that winter is soon, with the resultant shock from heating oil and oil-fired electric plant costs added to gas prices, and an oil shock is coming.

Also, the economy is slower than any econ likes. The savings rate is 'negative' - maeaning that more people are paying their credit card bills with savings than are saving. The world markets are getting reluctant to buy more US debt. And the housing bubble - that most long-term and predictable of gainers -is showing signs of leaks.

So what is Greenspan doing? At a guess, i'd say that he's groping for a way to have a coming economic crunch arrive in small dribs-and-drabs that can be coped with, rather than the end of Hoover's term.

So, for a starting signal he has some of the FedRes branches make badmouth re inflation. That is about the oil shock. It's multiple branches to indicate seriousness, but the minimum number to be some (3), and none of them Greenspan himself, so that it's not 100% 'official'. (Just official enough for the initiates to get, but not enough for newsies or Joe America to catch on.)

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At 1:09 PM, Blogger Cynicus said...
i guess whqt i'm trying to say is that, if you asked Greenspan, he'd say he's trying to "necessarily" scare the markets.

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At 2:00 PM, Blogger Stithmeister said...
That's the thing about Greenspan though. He's as much as admitted he doesn't know where he is here.

I do know China has no problem buy US funds though... they dedicate about 1/5th of their GNP towards the purchase of American moolah. Some other asian countries are doing that too though not nearly at the volume of the U.S.

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At 2:21 PM, Blogger Cynicus said...
Can we write off Taiwan in exchange for some of those bonds back?

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Location: Harrodsburg, Kentucky, United States

I'm currently working in the telecomm industry but one of my passions is still politics.

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