Larry CNBC's"no inflation" Kudlow, changes his tune:Now asks Fed to raise rates.
Or,
how soon fickle minded people change? GGGGGGG
TA
jetson.cnbc.com
Oct 22 1999 6:01AM ET
More on Economic Focus...
Quick Fed Action can Stifle Inflation
by Lawrence Kudlow
Chief Economist
CNBC.com
CNBC.com Chief Economist Lawrence Kudlow surprised a few readers recently
when he announced the Fed should raise interest rates. Let him explain?
Following the release of the latest consumer price report, which rose 2.6
percent from a year ago and at an annualized 3.5 percent over the past six
months, I remain concerned that inflation is creeping higher. The producer
price report earlier registered a 3.1-percent year-to-year gain in September, or
4.9 percent at an annual pace over the recent six months. Even temporarily,
too high.
Leading up to these price reports, which hint that inflation could be rising
above the Fed's implied zero- to 2-percent price rule inflation target, gold and
precious metals turned up this summer (from a low base), broad commodity
indexes increased modestly (following 18 months of deflation) and the overall
dollar index dropped slightly from its peak.
Perhaps most important, after two federal funds rate increases, 30-year
Treasury bond yields actually increased from about 5.8 percent to 6.3
percent. Traditionally, if Fed restraining actions successfully reduce future
inflation expectations, then long rates would decline even as short rates
increase.
But this has not yet happened. Today's spread between the actively traded
long bond yield and the fed funds rate is slightly more than 100 basis points,
nearly identical to the "policy" spread last spring before the Fed turned to a
more cautious approach.
Now, my point in all this is that the bond market sees some inflation, though
not much. Inflation signs are creeping up. Creeping, not galloping. This is
most assuredly not a 1970s threat. Nor, even, does it look like a late-80s
problem, when the inflation rate moved up to 5 percent from 2 percent.
Additionally, it is very unlikely that interest rates need to ratchet up as they
did in 1994.
Washington economist Alan Reynolds, who shares this creeping inflation
view, recently noted two additional threats. First, second-quarter import prices
(including oil) rose 1.6 percent, or a 6.8-percent annual rate. Updating this for
the third quarter, we find that import prices rose 2.5 percent, or 10.3-percent
annualized. This cuts into consumer buying power and will likely slow future
consumer spending.
Second, Reynolds notes that while the personal spending deflator (the CPI of
the national income GDP accounts) rose at a 2.2-percent annual rate in the
second quarter, prices of non-durable goods jumped at an outsized
5.3-percent yearly rate. For the third quarter, the non-durable component of
the CPI has increased at an annualized 4.6-percent pace.
Speaking of a possible consumer slowdown, my associate John Park reports
a clear link between the Bank of Tokyo-Mitsubishi leading index of chain store
sales and overall retail sales ex-autos. The accompanying chart shows the
downturn in the growth of this leading index, a trend shift implying that
non-auto retail sales growth could drop from nearly 8 percent to roughly 3
percent. Even a small non-energy shift in import prices can be a drag on
growth.
Source: Schroders
Now, contrary to the usual Phillips curve chorus of economists who believe
that strong growth and employment cause inflation to rise, the classical
monetary view asserts that declining money purchasing power generates
inflation. Then, rising inflation harms growth.
The message from lower bond prices and somewhat higher gold and
commodity prices, corroborated by the up-creep in government inflation
reports (flawed as they are), is that the value of dollar purchasing power has
eroded somewhat. Therefore, future growth is likely to be slightly lower, while
inflation will come in a bit higher.
Source: Schroders
This is likely to be a minor problem, not a major one. There's no recession in
sight. Next year's growth could be in the 2.5- to 3-percent zone, while general
inflation hovers around 2%.
There are risks, however. Mainstream Keynesians never acknowledge that
periods of rapid growth, such as the past four years or most of the 1980s, are
usually accompanied by slower inflation. In contrast, periods of slower growth,
such as the early '90s, or the '70s, are associated with higher inflation.
Should growth in fact slow, then the Fed must be aware of the likelihood that
the demand for money will also slow. Therefore, in order to avoid worsening
inflation, the central bank should withdraw liquidity to rebalance less money
demand with less money supply.
This is why I believe the Fed needs to drain reserves from the banking system
-- in order to prevent "excess liquidity" from accommodating higher oil prices
and other small price pressures.
This is also why the Fed should stop attacking the stock market and
economic growth. Central bankers must realize that "talking down" the
economy and the market really means talking down the dollar.
If investors in search of high economic and investment returns really believe
the Fed, then they will switch out of dollars into yen or other currencies where
future returns are more promising. This process would further reduce dollar
demand. The existing dollar supply would become excessive, or inflationary,
in relation to falling dollar demand.
Instead, Greenspan & Co. should broadcast their intent to keep inflation in a
zero- to 2-percent target zone. If price indexes rise above this target band,
then liquidity should be drained. If prices fall below the band, then liquidity
should be added.
Right now the near-$300 gold price suggests that future inflation will not be
much of a problem. My price rule and supply-side friends who believe that
recent inflation will prove temporary are likely to be right, though bond yields
remain a worry-wort.
I continue to believe that the Internet economy exerts an upward push to
economic growth and productivity, and a downward push to inflation. Over the
next few decades, the Internet will be much more important that the Fed.
However, I also believe the monetary scarcity creates purchasing power value
and zero inflation. This, in turn, creates a favorable growth climate for
technology entrepreneurs and their venture capital financiers.
So I think the Fed needs to drain reserves right now to maintain the
Greenspan standard of price stability. Aim policy at steady prices, not
economic growth. Growth should be nurtured, not harmed. Then the long bull
market prosperity boom will continue well into the new century.
CNBC.com Chief Economist Lawrence Kudlow also serves as chief economist of
Schroder & Company, Inc. |
