2 April 2007
It looks like the hawks were right: Inflation remains a concern -- in the United States as well as much of the rest of the world.
With all the important measures of inflation for February now available, it has become clear that inflation in the US economy has not been subdued.
On 16 March, the Labor Department reported that the consumer price index rose 0.4 percent in February while the core index excluding food and energy rose 0.2 percent. On a 12-month basis, the respective increases were 2.4 percent and 2.7 percent. These rates are higher than the Federal Reserve's preferred rates of 1-2 percent.
The Federal Reserve, though, prefers to look at the personal consumption expenditure price index as a measure of inflation. This measure, however, provided little consolation too.
On Friday, the Commerce Department reported that the overall PCE price index rose 0.4 percent in February while the core index rose 0.3 percent. On a 12-month basis, the respective increases were 2.3 percent and 2.4 percent, only slightly better than the rate of increase of the respective CPI measures.
Not only do these figures show that inflation remains somewhat elevated, they also show that the moderating trend in inflation that had been evident in late 2006 appears to have stalled, at least for now. They also vindicate the Federal Reserve's persistent tightening bias and concern about inflation. Inflation is not going to lie down and die any time soon.
Indeed, in a speech on 23 March at the Federal Reserve Bank of San Francisco, Federal Reserve governor Frederic Mishkin said that while the core PCE inflation rate is likely to "gradually drift down" to around 2 per cent, he is "less optimistic about the prospects for core PCE inflation to move much below 2 percent in the absence of a determined effort by monetary policy".
Among other developed economies, inflation concerns are mixed. The euro area has managed to keep its inflation rate below 2 percent, although its estimate for March showed an acceleration to 1.9 percent from 1.8 percent in February. In the United Kingdom, though, inflation has over the past few months been flirting with the 3-percent threshold that would require the Bank of England to write a letter of explanation to the government. On the other hand, Japan's inflation rate fell back into negative territory in February.
Milton Friedman said that inflation is always and everywhere a monetary phenomenon. Perhaps that explains why inflation has been so persistent; with the exception of Japan, growth in money supply in the major economies has also been persistent, accelerating strongly in the euro area and the UK.
The Federal Reserve does not pay much attention to monetary aggregates, but that has not stopped it from remaining concerned about inflation.
On the other hand, the European Central Bank does monitor monetary aggregates closely and is among the more hawkish of the major central banks. It raised interest rates last month by a quarter percentage point to 3.75 percent.
The Bank of England looks like a strong candidate to be the next major central bank to hike rates.
Even the Bank of Japan appears committed to further tightening of monetary policy, albeit at a very gradual pace. With Japan's population set to shrink, growth in its money supply has a relatively limited impact on real economic activity in Japan and tends to feed carry trades instead.
Other central banks that raised interest rates in March include those of New Zealand, Denmark, Switzerland and Norway.
It is not just developed economies that are tightening monetary policy. Over the past fortnight, the central banks of both China and India have raised interest rates as well.
So the general trend in global monetary policy still appears to be towards more monetary tightening, and the Federal Reserve is unlikely to swim against the tide by cutting rates any time soon.
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