Bernanke, Trichet Have to Sacrifice More Jobs to Curb Inflation
bloomberg.com
By Simon Kennedy
Aug. 21 (Bloomberg) -- When Ben S. Bernanke, Jean-Claude Trichet and other central bankers gather this week amid the comfortable resort surroundings of Jackson Hole, Wyoming, the talk will be of sacrifice.
Meeting at their annual conference, the bankers will hear in research papers and panel discussions that the cost of fighting inflation in terms of lost jobs and growth -- what economists call the ``sacrifice ratio'' -- is higher than it's ever been, and rising worldwide.
The pain is starting to be felt in the U.S., the result of the Federal Reserve's two-year campaign of interest-rate increases. And it may be even more acute for Trichet, president of the European Central Bank. Just as the $10 trillion economy of the dozen euro nations starts to outpace the U.S. for the first time since 2001, and with unemployment at a five-year low, he faces the prospect of raising rates higher and for longer than economists once anticipated.
With prices increasingly influenced by factors, such as developing countries' labor costs and raw-materials demand, that are outside their control, ``central banks must administer more pain to achieve the same effect on inflation,'' says David Kotok, who manages about $850 million as chairman and chief investment officer of Cumberland Advisors Inc. in Vineland, New Jersey. ``The ECB may even have to struggle more than the Fed did.''
The sacrifice ratio measures how much unemployment has to increase to bring inflation down by 1 percentage point. In the U.S., the ratio has risen to 4 percent from 2 to 3 percent during the mid-1980s, according to Fed economists.
Many More Jobs
That means many more jobs would need to be lost to achieve the same decline in inflation. Michael E. Feroli, an economist at JPMorgan Chase & Co. in New York, says that up until the mid- 1990s, an increase of 1.5 percentage points in the unemployment rate was enough to bring inflation down 1 percentage point.
``Now, the same reduction in inflation would take a 4 percentage point increase in the unemployment rate,'' he wrote in a report last month.
While the ECB doesn't publish an estimate of the ratio in the euro area, economists acknowledge the same trends are at work. Trichet has already raised the ECB's benchmark rate four times since early December, to 3 percent, and the euro has gained 8 percent against the dollar since the start of the year.
Even so, inflation has been above the bank's target of just below 2 percent for 18 consecutive months, and economists are lifting their forecasts of how much further it will raise borrowing costs.
4 Percent?
Stephane Deo, chief European economist at UBS AG in London, last week said he now expects the ECB's key rate to reach 3.75 percent next year rather than the 3.25 percent he previously envisaged. David Mackie, his counterpart at JPMorgan Chase & Co. in London, forecasts it will go as high as 4 percent.
As the world's economy becomes increasingly interdependent, central bankers can do little about price rises that originate with developments on the other side of the globe, such as increasing wages and environmental-cleanup costs in China. That means when inflation does pick up, Trichet, Fed Chairman Bernanke and their counterparts are hitting the brakes harder on the only economies they can influence: their own.
``The advance of globalization will tend to reduce the role of domestic factors in price determination over time,'' Kim Schoenholtz, senior economics adviser with Citigroup Inc. in New York, said in a report last month. ``As a result, larger policy swings eventually may be needed to secure price stability.''
`Comfort Zone'
In the U.S., inflation is still above what Bernanke calls his ``comfort zone,'' even after the string of 17 consecutive interest-rate increases, the longest since the 1970s, that ended this month. Fed policy makers held rates steady at their last meeting Aug. 8, waiting to see if the effect of their previous work will tame prices without their having to slow the economy any more.
Recent readings on the U.S. economy suggest Bernanke's Fed may already have paid the higher price demanded by its sacrifice ratio and can afford to wait. Housing, consumer spending on durable goods and business investment in equipment all contracted last quarter, and unemployment rose in July for the first time since February. A government report last week showed consumer prices rose at the slowest pace in five months in July.
The increase in sacrifice ratios coincides with the ascendancy of a more integrated and open world economy. For example, China's economy now wields more power abroad, having grown 10-fold since Deng Xiaoping began free-market reforms in 1978, overtaking the U.K. as the world's fourth-biggest in 2005.
Mixed Blessing
That is a mixed blessing for inflation-fighters. So far, China's cheap labor and low-cost exports have helped contain prices worldwide. Now, increasing wages and new environmental regulations, along with higher raw-materials prices, are pushing up the cost of manufacturing and in turn threatening to make its exports more expensive. China's demand for commodities such as oil and metals has also fanned inflation elsewhere.
``Maintaining price stability in a rapidly evolving, globalized economy becomes more essential and challenging, particularly in situations where inflationary pressures in some economies are now more easily transmitted to others,'' ECB Vice President Lucas Papademos said in a Madrid speech June 8.
San Francisco Fed President Janet Yellen warned in a May 27 speech in Santa Cruz, California, that a higher sacrifice ratio ``could complicate the Fed's job by making policy errors both easier to commit and more costly to repair.''
At some point, the Fed may find the price too high, says Richard Berner, chief U.S. economist at Morgan Stanley in New York.
``Inflation is still relatively low, and the Fed will find it hard to explain to Congress and the public why it should put a million people out of work for two years to reduce inflation by half a point,'' says Berner, another delegate to the Jackson Hole conference. ``Officials aren't certain any longer that the current comfort zone allows sufficient margin for error.''
To contact the reporter on this story: Simon Kennedy in Paris at skennedy4@bloomberg.net |
