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Inflation Numbers Increase (Again)

Oil is above $100 and Gold keeps pushing higher. This has many perplexed as a recession generally pushes prices for commodities down. This is not like a normal recession, if we are in the midst of one. The factors driving commodity prices higher transcend the US and its economy. The demographic changes around the world that have increased the demand for middle class lifestyle material goods is having a bigger impact than most pundits realize.

The article below discusses the growing inflationary pressures in our economy and the potential solutions available to the Fed, and whether the Fed will act on those in an election year. This is a new chapter in the economic playbook that the economists and the Fed appear not able to grasp. How it plays out will be a learning experience for everyone.

Another Discouraging Inflation Report

posted on: February 20, 2008 |

Anyone who thinks inflation isn’t a problem isn’t looking at the numbers. It’s not a huge problem, not a catastrophic problem, but it’s still a problem, and one that requires attention. Left untended, it’ll only get worse. And once the public thinks it’s destined to get worse, the Federal Reserve will be looking at a much bigger problem that could take a generation to reverse. The good news is that the problem is still manageable. Nonetheless, the clock is ticking.

This morning, the Bureau of Labor Statistics reported that consumer prices rose 4.3% during the 12 months through last month. As our chart below shows, that’s near the peak for the past 10 years. Core inflation (which excludes food and energy prices) is also pushing higher these days, running at a 2.5% annual pace, which is near its highest levels in recent years as well.

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Headline inflation is now far above the overall growth rate of the economy, which expanded by a paltry 0.6% in annualized real terms in last year’s fourth quarter. Even GDP’s 3.2% growth in nominal terms remains comfortably under CPI’s pace.

The inflationary pressure is all the more troubling with the Federal Reserve aggressively lowering interest rates of late, a course which increasingly looks like the monetary equivalent of throwing gasoline on a fire. Fed funds are currently 3.0%, down from 5.25% as recently as last September. As a result, Fed funds are now negative in inflation-adjusted terms. And more rate cuts may be coming. The April ’08 Fed funds futures contract is priced in anticipation of another 50 basis-point cut, which would bring rates down to 2.5%, or nearly 200 basis points below CPI’s pace.

Meanwhile, no one should mistake the inflationary momentum as a statistical artifact. The bubbling pricing pressure is evident in several crucial corners of goods and services. Food, energy, transportation and medical care prices are all advancing at annual rates above headline CPI’s pace, according to today’s government report.

The Fed has been expecting that the slowing economy would take the edge off inflation. So far, however, nothing of the sort is happening. As GDP’s pace has slowed, inflationary pressure has only risen. So much for wishful thinking. That leaves the traditional solution, which is one of embracing a hawkish monetary policy, at least relative to what currently prevails. That’s an awkward prescription in an election year, especially one in which recession threatens. But no one ever said that running a central bank is a short cut to popularity. It remains to be seen just how much popularity Mr. Bernanke and company seek.