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Rising Prices Put Pressure On Already Ailing Economy
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The combination of rising prices and a slowing economy have made life difficult for Federal Reserve Chairman Ben S. Bernanke and his colleagues. The central bank tries to maintain price stability and low unemployment, and yesterday's news suggests that it faces difficulties on both fronts.
At the last meeting of its policymaking committee, Fed leaders agreed that interest rates should be cut to stimulate the economy, but they "also recognized that the situation was quite fluid and the economic outlook unusually uncertain," according to minutes of the December meeting released yesterday.
In the view of market participants, the negative news about manufacturing trumped the worries about higher inflation. Based on pricing of futures contracts, the probability that the Fed would cut rates at its meeting Jan. 30 rose yesterday to 88 percent.
If inflationary pressures worsen, the decision could get trickier. "There's really no category that can give them a lot of relief," said Michael Swanson, an economist at Wells Fargo, noting that prices for a wide range of products are on the upswing.
Usually the central bank can fight off inflation by raising interest rates to slow an overheated economy. The sources of inflation now, however, are linked to global trends over which the Fed has little control.
The major reasons for the higher price of oil, for example, include strong growth in China and India, and reduced investment in new drilling when oil prices were low in the late 1990s and early 2000s. Those reasons would not necessarily change if the Fed increased interest rates.
And higher prices for corn are linked to the high price of oil and government incentives for ethanol production.
"Unless the Fed wants to drive the entire world into recession, it ain't going to do a lot about the price of oil," Naroff said. "And unless it takes over Congress, it can't do much about the price of corn."
The Commerce Department said yesterday that construction spending on single-family homes fell 5 percent in November, the largest monthly drop since 1993. Spending on other kinds of construction, mainly commercial buildings, rose more than expected. Private nonresidential construction rose 1.7 percent.
