Inflation Woes? Don’t Blame the Fed!

A few days ago, I wrote about how rising inflation is raising a few eyebrows among central bankers and policymakers. Since then, price levels have continued to climb nonstop, thanks to booming demand among emerging economies. On top of that, the ongoing ruckus in Egypt poses a huge threat to oil supply, as the possibility of another global oil crisis draws nearer.

Here’s a neat little supply-demand graph (Economics 101 flashback!) to illustrate the effects of these factors on price levels:

prices.png

As you can see by the shift from the blue to the red lines, higher demand combined with lower supply results to an overall increase in commodity prices. According to Federal Reserve Chairman Ben Bernanke, these are the two factors that contribute to rising inflation, and not the Fed’s quantitative easing moves.

However, several economic hotshots insist that the Fed‘s loose monetary policy, which flooded the markets with U.S. dollars, is to blame for the seemingly unstoppable rise in prices. After all, the purchasing power of money goes down if there’s more of it circulating in the economy, right? Well, imagine the impact of buying government bonds and pumping $600 billion into the economy!

blame.png

But Fed head Bernanke was quick to defend the central bank in his speech this week. Blame it on the a-a-a-alcohol, but don’t blame it on the Fed!

He pointed out that core inflation in the U.S. is contained at 0.7% in 2010, which was much lower than the 2.5% figure prior to the global recession. He also mentioned that, even though there are upside pressures on commodity prices, unemployment and spare capacity in the U.S. economy are likely to keep inflation subdued in the future.

With those reasons in mind, he stated that the Fed would continue to provide support of the U.S. in order for their economy to stay strong enough to withstand further challenges. In their recent meeting this January, FOMC members all agreed that the central bank should keep buying government bonds to ensure that the U.S. stays on track to full recovery. Although they acknowledged that some sectors are showing signs of improvement, they cautioned that the U.S. still has to deal with budget cuts which could dampen growth later on.

So it looks like everyone has their own laundry list of problems to deal with, and the U.S. economy is simply doing what it can in order to prop itself up. But while playing the blame game isn’t doing anyone any favors, the global economy also wouldn’t benefit if each nation selfishly protects its own interests only. I’m sure my buddy Cyclopip will laugh at me for quoting a line from the cheesy teenybopper movie High School Musical but, when it comes to global economic problems, “We’re all in this together.” Oh stop smirking, I know you know that song too!

I’d love to hear your thoughts on this inflation issue so feel free to drop a comment or vote in the poll below. And if you still haven’t, add us up on Facebook or follow us on Twitter to stay updated with my analysis on different economic issues. Thanks for checking out my blog!

12 comments

  1. sunglow

    Ben Bernanke seems to be singing from the same hymn sheet as Mervyn King, who is also intent on keeping interest rates low, despite inflation starting to increase at an alarming rate. However, the situation over here in England is somewhat different to that in the USA. Most of the commodities are priced in dollars and if the BOE increased interest rates, the GBP would rise against the dollar, thus reducing prices for consumers and industry alike. The fact that the BOE shows no sign of making such a move is somewhat disturbing.

    Reply
  2. sunglow

    Ben Bernanke seems to be singing from the same hymn sheet as Mervyn King, who is also intent on keeping interest rates low, despite inflation starting to increase at an alarming rate. However, the situation over here in England is somewhat different to that in the USA. Most of the commodities are priced in dollars and if the BOE increased interest rates, the GBP would rise against the dollar, thus reducing prices for consumers and industry alike. The fact that the BOE shows no sign of making such a move is somewhat disturbing.

    Reply
  3. Darkdoji

    From my reading of the yield curve and trends thereupon. Yields in the US are up and growing fast. Risk appetite is strong and the economy is expanding (however, the situation is anomalous or should be thought of as such until the job growth situation is clarified). Further, there are strong indications of future runaway inflation, which may account for high long end rates on the yield curve. QE2 appears to have masked this at the short end or may in fact be the wild card in this disjointed picture if not the affect. It is possible that growth is affected and a double dip results if this leads to a slowing down of mortgage and related loan uptake in the not too distant future (especially if job creation is indeed at levels so far indicated by the NFP series thus far). “Things fall apart and the centre cannot hold” I fear more turbulence ahead and little help from traditional inter-market relationships to guide the poor FX trader.

    Reply
  4. Darkdoji

    From my reading of the yield curve and trends thereupon. Yields in the US are up and growing fast. Risk appetite is strong and the economy is expanding (however, the situation is anomalous or should be thought of as such until the job growth situation is clarified). Further, there are strong indications of future runaway inflation, which may account for high long end rates on the yield curve. QE2 appears to have masked this at the short end or may in fact be the wild card in this disjointed picture if not the affect. It is possible that growth is affected and a double dip results if this leads to a slowing down of mortgage and related loan uptake in the not too distant future (especially if job creation is indeed at levels so far indicated by the NFP series thus far). “Things fall apart and the centre cannot hold” I fear more turbulence ahead and little help from traditional inter-market relationships to guide the poor FX trader.

    Reply
  5. Forex GumpForexGump

    Hey sunglow, thanks for checking out my blog! It’s true that an interest rate hike from the BOE could help tame inflation in the U.K. but I think the problem is that the central bank is worried that increasing borrowing costs could hurt overall economic growth. It doesn’t help that the U.K. printed a negative GDP reading lately and could be in for a double-dip recession once the impact of austerity measures kick in. It appears the BOE has hit an impasse between keeping price levels down for consumers and providing support for the economy.

    Reply
  6. Forex GumpForexGump

    Hey sunglow, thanks for checking out my blog! It’s true that an interest rate hike from the BOE could help tame inflation in the U.K. but I think the problem is that the central bank is worried that increasing borrowing costs could hurt overall economic growth. It doesn’t help that the U.K. printed a negative GDP reading lately and could be in for a double-dip recession once the impact of austerity measures kick in. It appears the BOE has hit an impasse between keeping price levels down for consumers and providing support for the economy.

    Reply
  7. Forex GumpForexGump

    Yes, Darkdoji, that’s what I’m worried about too. Sure, the U.S. economy is showing a lot of signs of improvement lately but that’s mostly because it’s propped up by QE2. I wonder if things could really fall apart as you say if they remove the stimulus…

    Reply
  8. Forex GumpForexGump

    Yes, Darkdoji, that’s what I’m worried about too. Sure, the U.S. economy is showing a lot of signs of improvement lately but that’s mostly because it’s propped up by QE2. I wonder if things could really fall apart as you say if they remove the stimulus…

    Reply

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