We live in an infinite-dimensional economy that is forever summarized by a one-dimensional statistics. Monetary policy is summed up in terms of a few numbers: short interest rates, long rates, CPI and its variations. It's very easy to miss the obvious if one just looks at these numbers.
New York Fed President Tim Geithner, in a recent speech, pointed out the obvious: "Research at the Federal Reserve and outside suggests that the scale of foreign official accumulation of U.S. assets has put downward pressure on U.S. interest rates, with estimates of the effect ranging from small to quite significant." In other words, the "federal funds rate" may be at historical neutral, but monetary policy is very loose, owing to the activity of (especially) foreign central banks.
If you look deeper than one-dimensional summaries, you can find the evidence: Despite high short rates, we have low long rates, the famous "conundrum". Despite low-ish headline and "core" CPI, check out the detailed CPI report.
Choose any category that is heavy on untradable services, and compare. Over 12 months, food at home is up 2.4%, food away from home (more service intensive) is up 3.0%. Alcohol at home, up 1.5%; alcohol at bars and restaurants, up 3.5%. Housing is up 4.0% overall. "Household furnishings and operations" are up only 0.6%, but most of that category is tradable goods. Look at the domestic "household operations" part (maids, gardeners, movers), you'll see it's up fully 5%! Medical care? Up 4% over 12 months. Recreation? Only up 1.1% But recreation includes TVs, bicycles, etc. — tradable goods. Drill down to the domestic-service-intensive components: Pet services are up 4.5%, recreation services up 3.2%. Education is up 6.2%. Personal care services (hairdressers, etc.) are an outlier on the low-side of the service universe, up only 2.5%. But "Miscellaneous personal services" are up 3.2% overall, and more for most subcategories. (Don't die! Funeral services are up 4.5%! If incentives really do matter, we'll all be immortal soon.)
The pattern is quite clear. Whatever is exposed to global competition is cheap, with low or even negative price growth. (Apparel, television, appliances, etc.) Pull this stuff out of the equation, and you'll see the traditional mark of an overloose monetary policy — inflation. Put it all together with Geithner's and Brad Setser's insights, and it is not so complicated a picture. Thanks to the behavior of foreign central banks, monetary policy is very loose, even with a historically "neutral-ish" US Fed Funds rate. The market-priced long-end of the yield curve is a more accurate gauge of effective liquidity than the controlled short end, which at best represents an intention. A loose monetary policy is creating inflation whenever dollar-paid Americans are producing the goods. But our "sophisticated capital markets" are mollified by "central tendencies" of CPI, PCE, in which the inflation is masked by low-priced imports. The same central bank behavior that creates the dollar liquidity creates artificially low prices (in the form of undervalued exchange rates) to help hide the inflation. The idiocy of crowds.
Adapted from a comment to a post of Brad Setser's.
|Steve Randy Waldman — Monday March 20, 2006 at 6:02pm||permalink|