Saturday, March 26, 2011

Circle the wagons...

...the Fed is using all available channels to communicate its "irreproachability" with regard to monetary policy. Most of the arguments contain the usual positivist outcomes as if economics were an exact science where one set of policies is obviously better than another set of policies equally reasoned but containing the opposite policy choices.

The inflation problem is most dependent on the prices of labor. Have we seen any pressure on wages lately? The below excerpt from a newspaper op-ed focuses on the effects of commodity price increases on headline or core levels of inflation.

Given that core inflation is close to 1 percent, overall inflation next year will likely also end up at about 1 percent, well below the Fed’s almost explicit objective of 2 percent.

But wait a moment, the Fed’s critics say. They like to point out that the data haven’t always told the same story about the link between underlying and overall inflation.

For instance, during the 1970s and early 1980s, an era of debilitating inflation, the markets had no confidence in the Fed’s ability to keep prices stable. This meant that any increase in prices, including those for volatile items like food and energy, were almost immediately and fully translated into expectations of higher overall inflation in the future. Those expectations, in turn, gave rise to actual increases in other prices, not just food and energy. (If workers expect that inflation will be 2 percent in the coming year, they will demand a wage increase that is 2 percentage points higher than they otherwise would to keep improving their standard of living.)

So in the ’70s, increases in food and gas prices affected both core and overall inflation. Some believe this is still the case today. But it isn’t.

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