It's The Economy Stupid

SEARCH BLOG: ECONOMY and FEDERAL RESERVE

I've said for awhile that the Federal Reserve [aka Federal (banking) Protection Agency] is either living on another planet or is living on another planet.

While housing and manufacturing tank, the Fed continues to focus on the price of energy [a globally driven phenomenon] and the price of food [driven by energy and some global warming nonsense policies such as ethanol].

Now that the dollar is reflecting the reality of a decade of over-importing [dropping like a hard turd], we can expect goods [imported or manufactured with imported components] to increase in price... fueling the Fed's worry about inflation and keeping interest rates high... fueling further housing and manufacturing and employment problems.

It seems that the Fed is positioning the U.S. for another one of its famous recessional "cures."

Perhaps it is correct that the only cure for import-addiction is a recession where buying shuts down. But I see that a recession would only further hurt the U.S. worker, while businesses seek lower and lower priced goods, labor and services from cheaper and cheaper sources... hoping to keep their ships afloat after the crews have been abandoned.

From Econbrowser:

The concern is then how broad the financial ramifications would prove to be if we see high default rates outside of the subprime categories. But I think Bernanke is unlikely to follow DeLong's advice, because the Fed Chair is in the same box he's been in all along-- fears about rising inflation. Returning to Bernanke's statement:

Sizable increases in food and energy prices have boosted overall inflation and eroded real incomes in recent months--both unwelcome developments. As measured by changes in the price index for personal consumption expenditures (PCE inflation), inflation ran at an annual rate of 4.4 percent over the first five months of this year, a rate that, if maintained, would clearly be inconsistent with the objective of price stability.

Bernanke remains hopeful, however, that the slow growth will bring inflation down. He was notably cautious about that prediction, however, offering numerical forecasts only on core rather than total PCE inflation:

The central tendency of FOMC participants' forecasts for core PCE inflation--2 to 2-1/4 percent for 2007 and 1-3/4 to 2 percent in 2008--is unchanged from February. If energy prices level off as currently anticipated, overall inflation should slow to a pace close to that of core inflation in coming quarters.

Bernanke noted that such an anticipation is plausible, with

futures prices suggesting that investors expect energy and other commodity prices to flatten out.

But Bernanke is also well aware that these futures-based forecasts historically have a huge forecasting error, and no one can rule out a continuation of the recent surge in energy and food prices.

All of which leaves the Fed no alternative but to keep the target fed funds rate steady for now. But I share DeLong's big worries, and suspect that Bernanke must to some degree as well. My guess is that if there is an interest rate change, a cut is more likely than an increase. The key variables to be watching at this point are real estate prices and the inventory of unsold homes.

Meanwhile, don't be fooled by the stock market's recent upsurge. Sooner or later, it will reflect reality.

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