Will Interest Rates Rise of Fall? Central Bankers Paralyzed

With recessionary forces fighting against inflationary forces, central bankers in the US and Europe don't know what to do, so they aren't doing anything.

It's tough being a central banker right now.  Ben S. Bernanke (US), Jean-Claude Trichet (ECB) and Mervyn King (UK) are stuck between a rock and a hard place.  What's the biggest threat?  Inflation or recession.  Bloomberg writes:

"Recessions are threatening to crash over the world economy in waves, as one country after another turns down a year after the onset of the global credit crisis.

Such rolling recessions pose a quandary for central bankers Ben S. Bernanke, Jean-Claude Trichet and Mervyn King: If the whole world were clearly slumping, they'd be united in cutting interest rates. Instead, with some countries still booming, they can't ignore the inflation threat. Paralyzed between slowing growth and accelerating prices, U.S. and European policy makers this week are set to fall back on keeping rates unchanged.

"We're in a peculiar situation where, a year from now, we're likely to look back and say that monetary policy makers have made a very, very serious error,'' says David Lipton, head of global country-risk management for New York-based Citigroup Inc. "The problem is, we don't know whether we're going to say they were too loose or too tight.''

My feeling, expressed by others on this site, is that rates are right where they should be.  Raising rates now would weaken an already weak economy.  A weak economy will take a bit out of inflation.  Perhaps most importantly, inflation will come down as oil prices and commodities continue to decline.  That decline is happening. 

Today, the Reuters/CRB commodity index had its biggest drop since March of 08.  Oil continues to fall and is now below $120 per barrel. Look for it to be under $100 by Jan 2009.  This will take a big bite out of inflationary pressure. 

The urge to "do something" is often the hardes urge to overcome.  Sometimes, doing nothing at all is the right approach.  Bernanke, Trichet and King should take the rest of the summer off.  

 

Sam Cass
Sam Cass: Sam Cass, MBA, JD, University of Texas at Austin. Always a fan of Leonardo Da Vinci.

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