Fed's Kohn addresses soaring oil prices and inflation
HARWICH -- Allowing inflation and unemployment to rise in the short-term would be an "appropriate" response by policy makers to soaring oils prices, Donald L. Kohn, vice chairman of the Federal Reserve, said today.
Kohn, speaking here at a conference sponsored by the Boston Federal Reserve Bank, said that moving to quickly bring down inflation in the face of oil and commodity price shocks could produce an sharp increase in unemployment.
Kohn noted that recent history shows big jumps in oil prices have had only "modest effects" on long-term inflation.
"It may be efficient to allow some adjustment period in which both overall inflation exceeds its desired low level and the unemployment rate is higher than its long-run sustainable level," Kohn said. "Setting policy in a manner that balances the undesirable effects of a shock to the system on both inflation and employment will tend to be more efficient than setting policy so as to deliver more extreme outcomes in either inflation or employment."
Kohn's remarks, made during a panel discussion with central bankers from other countries, reflect the tricky situation faced by the Fed. The economy is weak, perhaps in recession, while inflation is rising. If the Fed cuts interest rates further to give the economy a further boost, it risks sparking rapid inflation.
If it raises rates to stamp out inflation, it risks a deeper economic downturn.
The Fed has cut interest rates by 2.25 percentage points this year to try to right the listing economy, but rising energy and commodity prices, including food crops, have pushed inflation to its highest levels in years. Many economists expect the Fed to stop cutting rates when policy makers meet later this month.
Earlier this week, Fed Chairman Ben S. Bernanke addressed the conference. He said chances have improved that the nation will avoid a "substantial downturn" following the Fed's aggressive interest rate cuts and other actions, and the Fed will keep a close eye on inflation.
Kohn echoed Bernanke in that the Fed will act if expectations for higher long-term inflation threaten to take root.
Expectations are important because if consumers expect prices to rise quickly, they buy more in advance to avoid higher prices, adding to demand and pushing prices even higher. In addition, workers might demand higher wages to offset increased costs of living, leading producers to increase prices more. That's called a "wage-price spiral" which was a key component of the runaway inflation of the 1970s.
(By Robert Gavin, Globe staff)
Comment
Permalink
E-mail
