The debate is raging, from FTAlphaville:
Possibilities include weakening global demand; the recognition that the shale revolution has forever altered the political calculus for OPEC; surprisingly healthy output in some countries despite their internal turmoil, notably Nigeria, Iraq and Libya; and maybe some profit-taking from speculators. But it isn’t clear how much bearing each of these factors would have on the permanency of the effect.
The main point here is that it’s perfectly acceptable for the Fed to interpret the year’s fall in oil as a reason to keep policy loose, if only as a temporary precaution. And if, as Duy suspects, the short-term disinflationary impact later turns inflationary, then so much the better anyways. Inflation has averaged less than 1.5 per cent throughout this recovery; a period above the target would be no bad thing.
Greg Ip refers to this approach as opportunistic inflation. Bill Dudley says the economy should be allowed to run a little hot — meaning unemployment can be allowed to fall below the rate thought to signify full employment — to bring the long-term unemployed back into the jobs market and to goose inflation back to target. I’ve said, a little facetiously, that undershooting unemployment is the new overshooting inflation.
So while I agree with Tim Duy and with Gavyn Davies that the market probably now risks underestimating the Fed’s preference for sooner rate hikes, I also agree withRyan Avent, Ryan Cooper, and Paul Krugman that an itchy finger at the Fed would be regrettable and unnecessary.
Call the tradeoff what you will, but the risks of an early rate rise still seem greater than those of delay. Comparisons to 2011 don’t much alter the thinking behind this conclusion.
If you dig into this debate a bit the key point is that Bernanke was right that commodity inflation would subside in 2011 so the Fed can hike today based upon the reverse. From Tim Duy:
On the declining oil prices, I tend to view those as primarily supply side related and almost certainly a net positive for the US economy. Over the weekend Matt Busiginreminded us of this:
In April of 2011, Ben Bernanke was universally lambasted and lampooned for claiming that inflation, which was accelerating and running above 3%, was “transitory”. He used this view to justify loosening monetary policy. The next few months of CPI were not favourable to the Fed chairman’s views: it peaked at 3.8% (nearly double the implicit target at that point) in September of 2011, sparking a feverishly pitched cacophony of criticism that the Fed chair was out of touch, and tone-deaf in his theoretical ivory tower to the practical realities on the ground.
This, however, proved to be Bernanke’s finest hour. Yes, even more so than the extraordinary measures taken during the height of the credit crisis. His detractors then, of which there were still many, included people and institutions on the brink that needed the Fed to extend them a hand. In September of 2011, the chairman stood very much alone in his call for moderated inflation now that the acute disaster removed influential institutions and people from needing the Fed to act in order to survive….
…This is why Ben Bernanke’s 2011 triumph is relevant today. The same framework for understanding inflation through commodity prices and wages that successfully predicted the deceleration of inflation against the tidal wave of popular belief now finds itself in the inverse position: the expectations of inflation are very low, and despite low commodity prices, it expects inflation will accelerate…
You can read this for my similar take back in 2011. Rather than preventing inflation from returning to target, the oil price decline is likely to have the opposite impact and push inflation back to target. Hence the low-inflation argument for holding rates near zero will look weaker by June if not March.
I don’t buy it. Bernanke was right about inflation because commodity prices fell back as China finally succeeded in reining in its building boom, the MENA crisis passed and Europe descended into chaos, by early 2012 price were down 30%:
It’s the same this time. US wages may have warmed a little but tradable inflation is going to tank even if cheaper oil for consumers offsets the hit to US employment from the shale shakeout. The Fed will be forced to wait a little longer. That’s why gold is holding up.
