Half of John Mauldin’s column this week talks about the high-tech future of medicine, which of course, is interesting in and of itself. But in the first half of the essay, John gives us his reasons why he doesn’t believe the Fed is done raising rates yet - and I’m sure you won’t be surprised to hear “inflation” mentioned a few times:
First, there is that obscure item called the “sacrifice ratio.” How much pain in terms of a slower economy and lower employment do we take today to make sure we do not have excessive inflation in the future? Higher inflation in the future will ultimately mean even higher rates and a possible deep recession, as the Fed would then have to tighten aggressively. It is a trade-off or sacrifice. There is a number which characterizes the risks and rewards, called the sacrifice ratio, and today and for the last few years it has been high, which is why the Fed has continued to raise rates…
Second, the Fed is moving to inflation targeting. It is so far silent about this topic, but you can read the tea leaves. Bush just appointed Dr. Fred Mishkin to a recently vacated Board of Governors position. Just another academic economist? Hardly.
Mishkin was the co-author of Bernanke’s main economics textbook. One of the main points of the book was that central bank policy should be targeting inflation, with upper and lower bands of what the inflation number should be. (Also, I am pretty sure that there was a chapter in that text on the sacrifice ratio.)
So, Ben has a close friend who also believes in inflation targeting. There are a number of other new names on the board of late. Care to make a wager on how they feel about inflation targeting? If you read their speeches, you could certainly be forgiven if you come away with the impression that the recent rise in inflation is their #1 concern…
“the best “early-warning” measure of US inflation is not even widely published: it’s the Bureau of Labor Statistic’s harmonized measure of US inflation, using the methodology familiar to those who monitor inflationary developments in Europe. This measure was rising rapidly through 2004 when both the CPI and the PCE deflator were barely twitching…”
The different methodologies of calculating inflation in the US and Europe is a primary reason for Europe showing less GDP than the US over the past several years. The currency market was not fooled. Further, you can bet the Fed governors and economists are aware of these various methods which suggest inflation is a problem. It is just another reason why they sound as hawkish on inflation as they do.
