[OPE] The debate about inflationary pressures - a few clips

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In part, the Fed's decision turns on a distinction economists make between inflation and "relative-price changes." The former is a general loss of purchasing power that's caused, or at least exacerbated by, overly lax monetary policy (such as keeping interest rates too low for too long). The latter are price hikes driven primarily by fundamental shifts in supply and demand. If demand for commodities is spiking because of strong worldwide growth, the thinking goes, prices should rise accordingly, until consumers react by reducing consumption - a process that isn't apt to be influenced by interest rate changes. The Fed is betting that rising prices won't feed through to higher general inflation expectations unless workers start demanding raises and companies start raising prices. But wages haven't been rising sharply, and declining unionization means workers have less bargaining power than they did during the inflationary 1970s, economists say. And while some processors of commodities, like Dow, are charging more, their customers in turn have generally been unable to pass along those costs to consumers. (...) "Oil prices have ratcheted up over the past nine years and the dollar has depreciated for more than six years. Nevertheless, as long as a central bank is not creating an excessive amount of money, these relative price pressures ought to be transitory," Sandra Pianalto, president of the Federal Reserve Bank of Cleveland and a voting member this year of the Federal Open Market Committee, explained in a speech last month. "As consumers spend more money for higher-priced petroleum and agricultural goods," she continued, "they eventually have less money to spend on other goods and services. Other relative prices must then fall." http://money.cnn.com/2008/06/25/news/newsmakers/buffett_bernanke.fortune/index.htm?postversion=2008062608

June 2008 Executives around the world feel stymied by current economic conditions: although most respondents face rising inflation, almost half don't expect their companies to raise prices over the next six months, according to the latest McKinsey Global Survey. Furthermore, a significant number of executives aren't sure whether their companies will raise prices, suggesting that many find it difficult to project even near-term economic changes. The survey highlights just how much expectations of inflation have escalated over the past six months as food and energy prices have continued to rise: almost three-quarters of the executives now expect higher inflation, up from 60 percent (Exhibit 1). To make matters worse, more than 70 percent say that input costs have already increased (Exhibit 2). A quarter say that these costs rose in a range from 11 to 20 percent over the past six months. Not surprising, executives in manufacturing have been hardest hit-almost 90 percent report an increase in the cost of inputs. Executives in this sector cite rising energy costs as the global problem that had the greatest effect on the economic condition of their companies; the respondents overall, though concerned about inflation, chose the economic slowdown. Despite all this, executives say that the prices their companies charge won't keep pace with inflation (Exhibit 3). Just 37 percent of the respondents indicate that their companies raised prices in the past six months; 38 percent expect to be able to raise them over the next six. Only in the manufacturing sector-which suffered most from the rising cost of inputs-did a majority of the respondents say that their companies had raised prices and will continue to do so. http://www.mckinseyquarterly.com/Economic_Studies/Productivity_Performance/Economic_and_hiring_outlook_Second_Quarter_2008_A_McKinsey_Global_Survey_2160?gp=1

The U.S. slowdown, in theory, should be bringing down inflation as the economy uses fewer labor and other resources. And ongoing strains in U.S. financial markets - evidenced by the latest tumble in equity markets - as well as weak housing and rising unemployment make it hard to envision higher rates by the Fed. But while the slowdown appears to be keeping wage costs under control, headline inflation now tops 4% on an annual basis based on the consumer price index. It should approach or exceed 5% once recent oil-price gains are fully reflected in the data. Yet the danger in Kohn's remarks is that they may imply a certain helplessness on the part of the Fed. After all, under Kohn's apparent reasoning, even if the Fed were to raise interest rates, any effect on inflation might be muted if central banks in developing countries don't follow suit. And that perception could make things even worse for the Fed. If global investors lose even more confidence that the Fed can bring down inflation, then it might spur still more investment into commodities as an inflation hedge, pushing their prices even higher. The reason that central banks in foreign emerging countries do not hike interest rates is because the US Fed kept on cutting rates. Many have their exchange rates pegged to the US$. If they raise rates, they risk rapid currency appreciation against the US$. http://blogs.wsj.com/economics/2008/06/26/is-kohn-looking-to-outsource-global-inflation-fight/

The Algerian Energy Chakib Khelil, who is also chairman of the Organization of Oil Exporting Countries (OPEC) expects oil prices in the short term could rise to $ 170 per barrel. "I predict that the price in the summer in the northern hemisphere is likely to rise to $ 150 to $ 170 per barrel, possibly followed by a decline toward the end of the year", said Khelil. A further increase to $ 200 per barrel (159 litres) he called "unlikely". According to Khelil the weak dollar is the main reason for the continuing rise in oil prices, but tensions over Iran and Iraq and speculative investment also play a major role. "A decline of the dollar from 1 to 2% against the euro leads to a rise in oil prices by 8 dollars." Khelil said that it is increasingly difficult to find buyers at the current rates available on the oil market. Several large consumers of oil, including the United States, have demanded that OPEC increases production, but Khelil called the request "illogical and unrealistic." OPEC can open the oil tap more, only if there is more demand. 'That is not the case."
http://www.fd.nl/csFdArtikelen/WEB-HFD/y2008/m06/d26/olieprijs?t=OPEC_voorspelt_olieprijs_van_170_dollar_

But does the magnitude of inflation depend on what the government is spending money on? A study published recently by the Federal Reserve Bank of St. Louis says it does. Contrary to conventional wisdom, a comparison of 80 countries by economists Song Han of the Federal Reserve Board staff in Washington and Casey B. Mulligan of the University of Chicago found a significant negative correlation between nondefense government spending and inflation. That is, as countries spend more on nonmilitary expenditures, inflation tends to decrease. On the other hand, Han and Mulligan report a strong positive relationship between inflation and government size in times of war. Wars tend to lead to sudden booms in government spending. Using U.S. and U.K. data from as long ago as the 18th century, the authors found inflation rising as wars began and falling as they ended. The only exception was the aftermath of Vietnam War -one of the few American wars, the authors note, that didn't end in an unambiguous victory for the United States. "Inflation responds strongly," they write, "to the nature of how a war ends http://blogs.wsj.com/economics/2008/06/26/big-government-means-more-inflation-not/ 
 http://research.stlouisfed.org/publications/review/08/05/part2/Han.pdf

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