Fed’s manna from heaven seems to be ending

Yesterday I had pointed to a Charles Possner (Philadelphia Fed President) interview where he raised inflation pressures appear more broad based.

Today I read this recent speech from Jeff Lacker (Richmond Fed President) where he also suggests inflationary risks are building up:

As measured by the 12-month change in the PCE price index, inflation was 3.5 percent ending in June 2006. That measure of inflation fell to 1.8 percent in August 2007. Similarly, core inflation, which omits volatile food and energy prices, was 2.5 percent in August 2006, and then declined to 1.8 percent in August 2007.

Those declines were heartening, and when the financial market turmoil intensified in August the improving inflation picture allowed even an inflation hawk to endorse an easier monetary policy stance. Since August, however, the inflation picture has deteriorated.

In September and October, the overall PCE price index rose at a 3.3 percent annual rate, and the core index rose at a 2.6 percent rate. Judging by the closely related consumer price index, the numbers for November will be even worse. Now these numbers do display transitory swings, so I wouldn’t extrapolate them forward indefinitely. Still, I have to say that I am uncomfortable with the inflation picture, and disappointed that the improvement we saw earlier this year was not more lasting.

So now Fed members are getting concerned about rising inflation. He ends the speech by saying:

Going forward, markets expect oil prices to back off slightly from their current level, and I hope they are right. If energy prices fail to decline, monetary policy decisions will be that much more difficult in 2008.

This is the stance of many a economists and analysts (like me)- What will Fed do if inflation risks materialise and subprime woes continue? Which way will it swing?

Actually all this points to an irony. Fed is taking all these steps to prevent economy from slowing down but a slowdown would actually help inflation from rising. Inflation is expected to rise on account of rising food prices but can be moderated due to a slowdown in the economy. Slowdown means less demand and as a result prices do not increase as much.

Interesting times certainly.

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