[OPE] Interest rates redux

From: Jurriaan Bendien <jurriaanbendien@online.nl>
Date: Sun Jan 16 2011 - 11:25:21 EST

Martin Wolf ("The risks of raising interest rates too quickly", FT January
13 2011) writes:

To tighten or not to tighten, that is the question. It is one on which the
current UK discussion risks becoming more than a bit hysterical. Yes,
inflation is well above target. Yes, the Bank of England failed to forecast
this. Yet these facts are neither a necessary nor a sufficient argument for
tightening policy.

According to Johnny Akerholm, president of the Nordic Investment Bank, the
credit crisis was caused by interest rates so low that price inflation could
not balance the value appreciation of real estate. Akerholm said "the
interest rate is low, and the central banks print money while all prices
rise except consumer items". Thomas Hoenig of the Kansas central bank, a
strong opponent of Bernanke's quantitative easing, claims that "the danger
is that the policy response to a popped bubble creates a new bubble."
(Volkskrant, 31 Dec 2010, p. 5).

As I anticipated on OPE-L before, there are now growing disparities between
the increases in prices of different classes of goods, in other words,
differential price inflation. If you don't believe me, compare e.g. the
trend in the US consumer price index and the US producer's price index
(BLS). It is hardly possible, in the longer term, that, after a lull, the
PPI gains would not translate into CPI gains; that raises price inflation,
and then it makes interest rate hikes more likely. A few percent extra
inflation is hardly a serious problem (unless you are Frederic Mishkin),
particularly given historically low interest rates, but runaway inflation
is; but, runaway inflation is fairly unlikely in the medium term, since so
many workers are out of work. It seems, perhaps perversely, that
unemployment is the best guarantor against escalating inflation. The needs
of the masses are constrained by the ability to get the income to satisfy
them; they must do more for less, that is the austerity story.

Morgan Stanley analysts comment: "We think that higher risk premia and
strong capex demand will ultimately tip the balance in favour of higher real
interest rates. However, given the likely strength of saving in much of DM
[i.e. developed market economies - JB], the increase in real rates may end
up being relatively modest."


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Received on Sun Jan 16 11:26:54 2011

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