Source: The New York Times
This month, Ben Bernanke, the Federal Reserve chairman, broke from the usually banal official pronouncements about the dollar to talk bluntly about the risks of inflation. He told an international conference that a weakening dollar had caused an “unwelcome rise” in inflation and pledged to guard against such dangers.
Times Topics: Oil (Petroleum) and GasolineUntil this recent round of comments — which other Fed officials have now joined — the Fed had focused on the turmoil in the financial markets and slowing growth, not rising prices. With the markets relatively calm during most of June, it apparently felt freer to raise warnings about inflation. The Fed’s decision Wednesday to hold interest rates steady — after a string of cuts to stabilize financial markets and support the economy — underscored its growing concern about prices.
Then came Thursday and Friday. The stock market plunged into bear market territory, leaving no doubt that the credit crunch persists and the economy is still very fragile. At the same time, oil prices surged, sharply increasing inflationary pressure. The Fed would have preferred to deal with the threats of recession and inflation sequentially. But it does not have that luxury.
The Fed is in a bind. If it keeps rates low and loans plentiful to combat a recession, inflation could worsen. If it raises rates and tightens the money spigot to fight inflation, the downturn could be deepened and prolonged.
History may not be a reliable guide. It is easy — but not necessarily helpful — to draw analogies to eras like the stagflationary 1970s. Then, high prices led to higher wages and the dreaded wage-price spiral. Raising interest rates increased unemployment and slowed wage growth, choking inflation. But today, wages are barely budging, even as prices go up. Rate hikes to fight today’s inflation — which stem from commodity prices, not wages — may not be the fix they once were.
We don’t know how the Fed is going to get out of this bind. In the long run, however, the bigger challenge is not the Fed’s. Policy makers must come up with strategies to prevent the recession-and-inflation problem from happening time and again. Foremost would be a systematic plan for reducing the nation’s dependence on oil. From this perspective, high oil prices are actually a good thing — cutting use and spurring the development of alternative energy — but there must be help for the most hard-hit Americans, like lower-income workers.
The country first saw how high oil prices can wreak economic havoc with the oil shocks of the 1970s. Congress and presidents have failed to reduce America’s vulnerability by reducing its dependency. The Fed will have to feel its way through the current crisis. But the next president and Congress will have to tackle the oil problem once and for all.
