Hardly suprising!! the new LBVPHT category

Central Bankers Confront A New Inflation Calculus

Published on Saturday, January 26, 2008.

Source: Wall Street Journal

Central bankers pondering what to do in the event of a U.S. recession are finding that inflation just isn't what it used to be.

In the past, when the U.S. economy faltered, slack demand for everything from oil to wheat pushed global commodity prices lower. That made the jobs of central bankers easier: They could cut interest rates without worrying too much about inflation.

But several factors, including the surge in demand from emerging-market heavyweights like China, are set to keep commodity prices high during this downturn, putting policy makers and businesses in a pickle reminiscent of the stagflation-plagued 1970s.

In the short term, the quandary means central bankers across the globe may be reluctant to bring down rates as far or fast as they otherwise would to support growth. In the long term, it signals that the global golden age of low inflation may be ending.

In the past year, "the possibility of a sustained rise in commodity prices has jumped into the list of the top three things many of our clients worry about," Edward Nusbaum, chairman of the board of accounting and consultancy firm Grant Thornton International, said in an interview in Davos. Mr. Nusbaum was set to debate the topic Friday with other Davos bigwigs on a panel called "How Much for the Basics?"

Inflation angst is widespread. Italian Prime Minister Romano Prodi this month appointed an inflation czar, a post known as Mister Prezzi (Mr. Prices), to keep an eye on rising consumer costs. Chinese Premier Wen Jiabao has said persistently high oil prices, rising agricultural-product prices and financial instability pose new problems for the global economy.
'Real Risk of Stagflation'

Developing countries are particularly vulnerable. "There is a real risk of stagflation in these countries, with drastic consequences," said Columbia University economics professor and Nobel laureate Joseph Stiglitz in an interview in Davos. Food and energy make up a far larger share of price indexes in developing countries, where many people lack the wherewithal to absorb higher prices.

To be sure, the inflation spikes of the 1970s aren't likely to stage a global comeback. World-wide, rates of inflation start from a far lower level than in the '70s. Japan hasn't completely licked deflation. A severe U.S. recession could yet puncture a commodity-price bubble or offset it with falling prices elsewhere in the world economy.

But after years of persistently low inflation, prices are rising at a faster clip in the developed world -- and some of the jumps in food and energy prices are spilling over into other areas. From 1996 to 2006, consumer prices in advanced economies rose 1.9% a year, on average, according to the International Monetary Fund. Last year they rose 2.4%. In a conference call with investors yesterday, Hershey Co. Chief Executive David West said the candy maker has seen "an unprecedented run-up in costs over the last couple of years."

That is worrying U.S. Federal Reserve Chairman Ben Bernanke. The threat of similar spillovers also is preoccupying the European Central Bank. Headline inflation in the 15 countries that use the euro hit a 6½-year high of 3.1% in November and December, well above the ECB's preferred range of just below 2%. Persistent inflation pressures and the threat of a wage-price spiral underlie the ECB's reluctance to follow the Fed in cutting interest rates, despite signs of slowing euro-zone growth.

Some economists worry that rising prices will prevent rate cuts by the ECB and the Bank of England -- which, unlike the Fed, have inflation control as a primary mandate -- and so worsen the coming slowdown. "The biggest concern at the moment is that these central banks could hold on too long and therefore exacerbate the downside of the growth outlook because of their concerns about the inflationary environment," said Stuart Green, economist with HSBC in London.

A New Inflation Calculus

The new global inflation calculus has several causes. In the U.S., the productivity gains of the 1990s tech boom are wearing thin, and companies today are more focused on things like share buybacks than investment in plants and equipment. As a result, the economy can't grow as quickly without stirring inflation.

Many economists, including former U.S. Fed Chairman Alan Greenspan, also argue that the entry of millions of Chinese, Indian and former communist-country workers into the world economy was a one-time disinflationary force that is losing its oomph.

Globally, increasing emerging-market demand appears to be putting prices of food and energy on what may be on a long upward path. Powerhouses such as China and India are at a particularly resource-intensive phase of development. Burgeoning middle classes are shifting to more protein-rich diets, sending meat, milk and feed-grain prices higher. As more people buy cars, air conditioners, televisions and the like, demand for raw materials rises. Developing-market infrastructure needs also are contributing, as is a focus on commodity-hungry industries.

But some economists say accepting strained resources as a long-term inflationary force means accepting the argument that emerging markets will continue to surge even as U.S. growth slows. Not everyone buys that.

"A good part of what we are seeing in commodity prices today is cyclical and not long-term trend," said Kenneth Rogoff, a Harvard University economics professor and a Davos regular, in an interview. "If the U.S. really goes into a deep, prolonged recession, commodity prices are going to get slammed."

Write to Joellen Perry at joellen.perry@wsj.com and Justin Lahart at justin.lahart@wsj.com

Copyright © 2006-2007
BlackListedNews.com var sc_project=1395741; var sc_invisible=0; var sc_partition=11; var sc_security="f60043ab";