ABA Banking Journal - April 2008 - (Page 60)

briefing The Economy EUGENIO J. ALEMAN Senior Economist, Wells Fargo Talking down inflation—markets not buying ALL THOSE “IMPORTANT” AND “famous” economists that have been arguing for almost a year that inflation was not a problem for the U.S. economy seem to have changed their minds in the last few weeks; talk about being “data driven!” The basic problem of being a data-driven economist is that you lose the big picture and forget about the essentials of economic theory. However, those economists that derive their analysis from sound economic theory saw this coming for a long time, even though we were dismissed. We know that what the Federal Reserve is doing in this commodity price environment is very, very, very risky. So far, Ben Bernanke and his followers have been very lucky, to say the least. Why? Because inflation expectations have remained well contained, as the chairman likes to say. He has been working under the assumption that firms and individuals truly believe that the Fed has inflation under control. But what does it take for firms and individuals to lose their faith in the ability of the Federal Reserve to keep inflation under control? Lamentably, nobody knows. And that is the biggest risk we are facing today in the U.S. economy. The Fed chairman is correct in saying that today’s environment is very different from that of the stagflationary years of the 1970s and 1980s. The U.S. and the world economy suffered a shock in January of 1974, when the price of oil went from $4.31 per barrel to $10.11 per barrel, an increase of 135% in one month and then continued its upward spiral after that! Today’s increase in the price of petroleum has been different, it has been 60 APRIL 2008/ABA BANKING JOURNAL several years in the making. However, this does not mean that oil prices are not going to have a similar effect on inflation. The only difference is that the latest increase in petroleum prices has been slower to come about. Recall the story of the frog that would never enter a water receptacle if the water was very hot, but it will be cooked to death if we start slowly increasing the resort. However, are we willing to accept much higher inflation in the future to prevent some financial institutions from failing? Lower interest rates are not going to bring back the housing market. The housing market remains in recession with no signs of recovery in the shortrun. Furthermore, I can understand Ben Bernanke’s attempts to talk down 16.00 14.00 12.00 10.00 8.00 6.00 4.00 2.00 0.00 -2.00 Consumer price index (% change year over year) -4.00 1/50 1/53 1/56 1/59 1/62 1/65 1/68 1/71 1/74 1/77 1/80 1/83 1/86 1/89 1/92 1/95 1/98 1/01 1/04 1/07 temperature of the water. The same thing is happening today. It seems that nobody realizes the risks of this slowly increasing water temperature called inflation. Thus, inflation is going to go up further; it is just a matter of time. I know that I am writing this from an analyst position and not as a policymaker. I understand that the problems created by the credit crunch are not easy to resolve. Bailing out the financial markets is the responsibility of the Federal Reserve as a lender of last inflation because that is his responsibility. He has to convince us that inflation is not going to increase, otherwise inflationary expectations could get out of control and then the Federal Reserve will have no choice but to increase interest rates very fast. However, I cannot understand the rest of the “important” and “famous” economists using Bernanke’s lines. Or perhaps they are all practicing for when they are Federal Reserve Chairman. Who knows! BJ www.ababj.com/subscribe.html http://www.ababj.com/subscribe.html

Table of Contents Feed for the Digital Edition of ABA Banking Journal - April 2008

ABA Banking Journal - April 2008 Contents Editor's Column You Can't Beat Wal-Mart: Or Can You? Snapshot: Non-Interest Income Shoulders More Weight ABA National Conference for Community Bankers Report 100th Anniversary: Then & Now ABA Resources ABA Chairman's Position Banks Plus Insurance: How to Make It Work Pass the Aspirin 2008: Year of Rich Internet Apps? Tough Time For That IPO Your Audience Needs to Know Who You Are Telepresence: Costly But Very Cool Webnotes Better Websites Mean Tougher Compliance Mailbox Banker's Mart To Advertise/Index of Advertisers The Economy

ABA Banking Journal - April 2008

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