U.S. Federal Reserve officials Thursday gave different views on what should be done about surging commodity prices, underscoring a deepening divide about inflation at the Fed and among major central banks.
Fed Board governors Daniel Tarullo and Elizabeth Duke, two regulatory experts who seldom talk about the economy and monetary policy, went out of their way to talk down inflation worries caused by the higher prices for oil, grains and metals.
By contrast, citing a “remarkable turn of events” where commodity prices have surged, Philadelphia Fed President Charles Plosser said he is growing worried about waiting too long to rein in inflation.
Top decision-makers at the Fed, including Chairman Ben Bernanke, don’t believe the central bank should rush to raise interest rates because the commodity price increase is likely to have a temporary impact on broader inflation. But a vocal minority at the U.S. central bank is growing restless–and policymakers in other parts of the world are also taking a different approach.
Reflecting the dominant view at the Fed, Tarullo and Duke indicated it’s not yet time to tighten credit because the economy remains fragile and the U.S. central bank may regret moving too soon.
Duke suggested inflation may stop rising because the commodity price increases are likely a result of supply and demand factors, which could change. “It would not be helpful if monetary policy reacted to every move in a very volatile price,” Duke said.
Tarullo said looking at so-called core inflation, which strips out volatile food and energy items and remains below the Fed’s informal 2.0% target, is better to set monetary policy, which acts with a lag.
“In the U.S. context…it’s proven a more appropriate metric since there’s a better correlation between core inflation today and inflation tomorrow,” Tarullo said.
A former Georgetown University law professor and the Fed’s point man on bank supervision, Tarullo normally sticks to regulatory issues. He was speaking on the sidelines of a meeting of global financial leaders at the International Monetary Fund.
In an outlook paper that sets the tone for the IMF-World Bank meetings, the IMF this week said the surge in oil prices is one of the biggest threats to the global economy. Opening the meetings Thursday, World Bank President Robert Zoellick warned of rising food inflation.
The European Central Bank, which looks at inflation measures that include food and energy items and show prices rising above its 2.0% target, last week raised rates from rock-bottom levels for the first time since the global financial crisis. The Bank of England is also expected to tighten credit by this summer to keep U.K. inflation in check.
The Fed is in no hurry to follow suit — and that’s a concern for officials like Plosser. In his speech Thursday, he said the Fed may be losing the public’s confidence that it is an effective inflation fighter and needs to take steps to ensure it doesn’t lose any more ground. He added interest rates may need to rise this year.
A similar trans-Atlantic debate about inflation took place in the first half of 2008, when soaring commodity prices led the ECB to raise interest rates in July 2008, before the financial crisis intensified. Europe’s monetary authority was later forced to reverse course, but ECB President Jean-Claude Trichet maintained it helped restrain inflation expectations, keeping inflation-adjusted rates lower than in the U.S.
Most Fed officials are comfortable with keeping rates close to zero as long as inflation expectations don’t rise; that is, if households and businesses begin to expect that higher inflation will take off in the long run.
Fed Vice Chair Janet Yellen Monday vowed the U.S. central bank won’t repeat the mistakes of the 1970s, when high oil prices led to sharp increases in consumer prices. As long as inflation expectations remain stable, the increases seen so far in global commodity prices and headline inflation are unlikely to lead to the wage-price spiral seen in the past, she said.
Plosser said he’s “not panicked” by what’s happening with inflation expectations, but at the same time, it is hard to say where the tipping point for something more ominous will be found. “I think we have to be careful not to get behind the curve here,” he warned.
Economists at Deutsche Bank Thursday put out a note entitled “Memo to Fed: Do not ignore commodities.” They don’t believe that food and energy price gains are transitory.
“In fact, when we look over a several-year period, we find that food and energy prices almost always rise–they only tend to fall in recessions,” they warned.
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