Dallas Fed's Fisher Changes His Tune On Globalization's Inflation Effects
By GREG IP
June 6, 2007
A Fed policy maker who has long championed globalization's influence on U.S. inflation says that influence has gone from good to bad.
"I sense that global capacity has moved from being a tailwind to a headwind in terms of inflation control," Federal Reserve Bank of Dallas President Richard Fisher said in an interview.
The Fed has traditionally considered the degree of spare capacity in the U.S. economy an important determinant of inflation. For example, in the short run, unusually low unemployment -- a measure of spare capacity in the labor market -- has traditionally contributed to higher inflation. Since taking his current job in 2005, Mr. Fisher has sought to elevate the importance of global capacity in monetary policy deliberations, on the premise that with so much production now conducted in a global market, U.S. prices are increasingly affected by surpluses and scarcities of capital, labor and resources world-wide.
Now, he says the world is running out of capacity, a factor that is adding to inflation risks in the U.S. Some Fed officials disagree that global capacity is significant for U.S. inflation; scholars are divided, too. Still, recently Fed officials have increasingly acknowledged risks on that front. At their May 9 policy meeting they "expressed some concern that the strength of global demand could contribute to price pressures at home," minutes to the meeting say.
Mr. Fisher isn't the first person at the Fed to have raised the connection between global capacity and U.S. inflation. Former chairman Alan Greenspan did so in the waning years of his chairmanship. Because of globalization, "many economies are increasingly exposed to the rigors of international competition and comparative advantage," he said in 2005. "In the process, lower prices for some goods and services produced by our trading partners have competitively suppressed domestic price pressures." (Read the speech1.)
In May, two economists at the Bank for International Settlements published a study2 that found that for many countries, "global measures appear to have supplanted the role of domestic measures of economic slack" in determining inflation.
Yet others remained skeptical. On Tuesday, current Chairman Ben Bernanke was asked at a conference in South Africa whether the emerging markets had become a source of inflationary pressure. He said it wasn't clear China had previously been pushing down global inflation, noting the impact of its demand on commodity prices. "If wages rise in China at some point, the costs of Chinese imports may be not quite as low… That would have some effect obviously on short run inflation dynamics in the U.S. and other industrial countries. My own sense is it's a modest effect." (Read the speech3.)
Indeed, a study4 by four Fed staffers published in April found "little support" for the link between global capacity and domestic inflation. The effect is generally "insignificant and often of the wrong sign," meaning inflation goes in the opposite direction that one would have expected if global capacity were an influence.
In an interview with The Wall Street Journal on May 22, Mr. Fisher said he has heard from many business people who say they face higher costs from foreign suppliers. He also acknowledges that while recent core inflation readings have been benign, he has begun to pay more attention to the total or "headline" inflation rate because unlike the core, it includes energy and food prices, which have been rising steadily.
Here are some excerpts from Mr. Fisher's interview. Some questions were edited for clarity:
Wall Street Journal: Is global capacity still putting downward pressure on inflation?
Fisher: I sense that global capacity has moved from being a tailwind to a headwind in terms of inflation control. I don't know with mathematical precision the intensity of those headwinds, but I do sense the winds have shifted. Both import prices and the reports I get from global business operators indicate that globalization may well be imparting upward pressure on prices.
What I'm picking up from my contacts around the world and not just among U.S. companies, is that there is pricing "temptation." Before every FOMC meeting, I consult among a group of some 50 CEOs whose operations have a global footprint. What I've been hearing over the last several months, particularly the last six months or so, is that global operations are no longer a source of disinflation in the U.S.: capacity constraints and price pressures are being felt, from commodities to shipping resources to a shortage of high skilled workers, globally. They see it reflected in import prices, which have begun to move in an upward direction. There is a sense things are more expensive because other countries are growing and straining against capacity constraints. The prices of some tasks that are allocated to overseas sources are more expensive. More and more, I hear people complain about the rising costs of Indian MBAs or the wages paid to Chinese workers.
Q: The latest data on core inflation has been seen as benign. What's your take?
A: The core measures look a little better than the overall inflation numbers. Both food and energy have had a steep upward tilt for the last three years in a row. Under those circumstances, I'm personally reluctant to put complete faith in the core measures because they may be removing more signal than noise.
You can see in the most recent inflation data some encouraging signs as you analyze the entrails. In the core measurement, for example, "owners equivalent rent" costs are growing more slowly. And yet overall inflation has been stubborn. It's staying above the 2% range. Then when I talk to business people, I hear concern, not just about fuel and corn and other commodity prices, but about higher-cost labor pools -- at both the high and non- skilled ends. Which feeds into their anxiety about preserving their margins. So I have adopted a "trust but verify" approach to inflation here.
Other central banks are in a tightening mode. You have long and uncertain lags between increasing interest rates and subsequent impacts … it may be too soon to expect inflation to subside to desired levels. Even though the numbers, in terms of OER (owners' equivalent rent) and some of the other entrails of the core, look promising, people are seeing and feeling less disinflationary input prices, including in services, than they were feeling before.
Q: From your business contacts, do you hear increased determination to raise prices?
A: The natural instinct of any business man or woman is to protect your margins. American business women and men have used cyber-enhanced globalization to squeeze down their cost of goods sold and ramp up their productivity. When that string is run, the way to preserve margins is to grow the top line either through volume expansion or more aggressive pricing. There's always a temptation to act on the price front. Our job at the Fed is not to give anyone encouragement to do so -- to prevent that temptation from metastasizing.
Q: What's your sense of how the economy is performing?
A: I don't like to speak of a "soft" or a "hard" landing. Landing implies that you come to a stop. The economy is running at a slower cruising speed presently. [But] I still lose a little more sleep on the inflation side than on the growth side.
Write to Greg Ip at greg.ip@wsj.com5 |
