Federal Reserve & Interest Rates

Fed Chairman Ben S. Bernanke gave a testimony Before the Committee on the Budget, U.S. House of Representatives. He discussed the economic outlook. He expressed concerns about inflation. The Chairman described the inflation problems as follows:

The same increase in oil prices that may be a negative influence on growth is also lifting overall consumer prices. Last year, food prices also increased exceptionally rapidly by recent standards, further boosting overall consumer price inflation. The most recent reading on overall personal consumption expenditure inflation showed that prices in November were 3.6 percent higher than they were a year earlier. Core price inflation (which excludes prices of food and energy) has stepped up recently as well, with November prices up almost 2-1/4 percent from a year earlier. Part of this rise may reflect pass-through of energy costs to the prices of core consumer goods and services, as well as the effects of the depreciation of the dollar on import prices, although some other prices

Bernanke went on to say that the markets suggest that the decline of food and energy prices will begin during this year. Core inflation should moderate for about two years, as long “as the public’s confidence in the Federal Reserve’s commitment to price stability is unshaken,” the Chairman said. He also noted that if the well-anchored public expectations of inflation in the future destabilize, it could “greatly complicate the task of sustaining price stability…” The Federal Reserve will be monitoring inflation, and public expectations continuously.

According to the Associated Press, “inflation is at the highest rate in almost two decades. Consumer prices rose by 4.1 percent for all of 2007, up sharply from a 2.5 percent increase in 2006, the Labor Department said Wednesday. Consumers felt the pain when they filled up their gas tanks or shopped for groceries. Prices for both energy and food shot up by the largest amount since 1990.”

Reuters columnist James Shaft thinks that we have more pressing concerns than inflation. After interviewing economic advisor George Magnus, Shaft reported the following comments: “The strong probability is that we will get at least disinflation in 2008,” said George Magnus, senior economic advisor to UBS. He continued, “I’m not aware of any banking crisis in history, almost without exception, that was not accompanied by falling inflation.”

The FOMC has made it clear recently that they are poised to cut rates at the next meeting. Magnus expressed to Shaft that “even aggressive cuts in interest rates will have a limited and painfully slow impact on demand under these circumstances…When solvency is involved and asset prices are declining, monetary policy can help but can’t solve the problem.”

Inflation is at the forefront of concerns for the Fed, as it has been for the passed several months. It isn’t something to panic about for now, however, it should not come as a surprise if we pay more for our milk and bread.