Friday, November 04, 2005


No 'Clear Way' To Fight Inflation?

This New York Times editorial reveals that many at the don't even know what inflation is anymore. "Early in his tenure as chairman of the Federal Reserve, Alan Greenspan declared that the risk of too much inflation was so considerable that he would 'err more on the side of restrictiveness than of stimulus.' Mr. Bernanke faces a fundamentally different set of circumstances than those that Mr. Greenspan confronted 18 years ago."

"'Inflation is clearly not right around the corner like it used to be,' said Edward M. Gramlich, until recently a Fed governor. 'The relationships are different, and Mr. Bernanke is going to have to figure them out.'"

"Perhaps the biggest differences are the rise of global production, as well as much easier access to capital, particularly from abroad. Adding to the change is labor's weaker bargaining power. These factors have combined to greatly diminish the force of old-style inflation."

"Instead, a new style of inflation has emerged as one of the principal threats to the economy. It is evident in the stock market bubble of the late 1990's and in surging home prices in this decade. This asset price spiral, as it is called, has proved much more resistant to the Fed's standard interest rate tool than traditional inflation."

"What lifts asset prices, Mr. Bernanke and others argue, is the willingness of lenders to offer riskier types of loans, which 'juice up the housing market and are not very responsive to interest rates,' as (economist) Mark Zandi put it."

"Lenders can engage in riskier loans because they have developed techniques in recent years that make it far easier for them to shed their vulnerability to risk, doing so mainly by shifting the risk of default to others. The lenders operate in sophisticated markets that allow thousands of individual investors to purchase a slice of the original loan, and a slice of the risk."

"Mr. Bernanke, in response to the risk shifting, has raised the possibility of limiting the dangers through the use of regulations, microregulatory policy, he calls it. 'There are two ways to approach bubbles: one is interest rate policy, the other is microregulatory policy,' he said in a little noted interview published last year. 'Microregulatory policy is the much better approach, in my view,' Mr. Bernanke said."

"He added: 'Research on historical episodes suggests that large asset price increases are sometimes preceded by credit booms. In many cases, this pattern results from the fact that the country in question deregulated its banking system, giving banks extra powers, but did not enhance the supervisory structure adequately at the same time.'"

"'Whereas in 1987, it was clear that the way to combat inflation was to raise interest rates," said Brian Sack, who once wrote a research paper with Mr. Bernanke, 'today the Fed's policy makers have to be cognizant that the higher energy prices are slowing the economy' on their own."

"To be sure, the gradual shift to a more global economy and the vast expansion of global capital markets have not left the central bank with no inflation to fight. But the dynamics have changed."

If this article is accurate we could be in more trouble than I thought. Then again, defaltion has vexed the Fed for years and maybe they are just at a loss as to how to confront it.
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