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Today, virtually everyone expects the Federal Reserve Open Market Committee to keep the federal funds rate steady at two percent. Attention will be focused on its sentiments about inflation in the policy statement, instead of structural problems besetting banking and halting growth.
Sadly, inflation hawks at the Fed have the Open Market Committee focused on inflation that has happened, and not on where the economy is headed or the constraints on monetary policy that will make effective Fed action difficult the second half of 2008.
Surging global demand and fleeting supplies of oil in non-Persian Gulf countries and restrictions on imports from the Gulf pushed up oil prices through June. Surging gasoline and grain prices, driven up by those forces and the U.S. shift to ethanol, pushed up inflation in the second quarter but those forces are abating. Moreover, there is no sign that inflation expectations have been built into wage setting and productivity gains remain strong.
Look outside. Oil and gasoline prices are falling, retailers face considerable difficulty passing along higher wholesale prices demanded by manufacturers and importers, and the economy. Pressures on global oil and commodity prices should ease the second half, and the realities of flagging demand in the U.S. market will require foreign purveyors of consumer goods in the United States and American manufacturers to hold the line on prices. Gasoline prices will ease, leaving only food prices as a source of concern.
The credit crisis could redouble its impact on the U.S. economy. Now credit card defaults are threatening the balance sheets of Citigroup and other big banks, bedeviled by slippery management, much as the subprime mess did over the last year.
Business credit will tighten. Non-Fannie Mae and Freddie Mac mortgages will get even scarcer, and half built suburban developments will start looking like a scene from an Armageddon movie. The Fed will likely be stuck with bad paper from Citigroup, J.P. Morgan and other money center banks and primary dealers in its “special facilities” for a long time.
Meanwhile, under our peculiar free trade arrangement with China, Beijing really sets U.S. monetary policy. Exempt by the Bush Administration from WTO requirements regarding currency policies, China purchases dollars and Euros for yuan in foreign exchange markets to keep its currency and goods cheap for Americans, and invests much of the proceeds in western bond markets. Capable of pumping up to $500 billion into U.S., European and other credit markets with the proceeds of this intervention, it will continue to determine the availability of liquidity and monetary policy.
The Fed statement will express concern about inflation and stress in credit markets and pretend the Fed can act to affect either one. The Fed would do better to start making access to its special lending facilities to a real cleaning up of banking practices on Wall Street, and advocate policies to unlink the dollar from the grip of Chinese monetary policy.
Sadly those most obsessed about inflation, such as Richard Fisher, earned their positions on the Open Market Committee putting in place the credit market conditions and free trade agreements that now so bedevil U.S. monetary policy. Solid Bush ideologues, they somehow think it will help to tighten credit to combat inflation in the rear view mirror, when the country’s banks are gripped in a crisis of confidence and the economy is headed south.
It is important to remember the physicians who bled George Washington during his dying hours were in step with the medical science of their time, as much as Fisher and his allies are with modern monetarism.
PETER MORICI is a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission.