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"A precondition for such a tightening is a relaxation of exchange rate targeting"
Removal of the famous "Greenspan put"
On Monday, June 9, Bernanke gave a pathbreaking speech entitled "Outstanding Issues in the Analysis of Inflation"
In two sentences, he contributed to a sharp, fifty-basis-point rise in two-year bond yields. Bernanke said:
[T]he latest round of increases in energy prices has added to the upside risks to inflation and inflation expectations. The Federal Open Market Committee will strongly resist an erosion of longer-term inflation expectations, as an unanchoring of those expectations would be destabilizing for growth as well as for inflation.
With those two sentences, Bernanke embarked on a path that may lead to whereby the Fed avoids policy measures that could cause systemic risk in financial markets.
John H. Makin, June 26, 2008
If there were a Central Bank of the World its monetary policy committee would glance at today’s inflation rates and expectations of future inflation and then raise interest rates.
There is no such bank, but there is something close: the US Federal Reserve, the monetary policy of which is mirrored by many countries in the Middle East and Asia.
low Fed interest rates are contributing to global inflation.
The Fed sets interest rates for Asian countries because, explicitly or not, they manage their exchange rates against the dollar.
If US interest rates are low, countries targeting the dollar are obliged to follow, because otherwise investors will sell dollars to buy their currency.
Financial Times editorial, June 25 2008
The greater the inflationary pressure, and the more Asian countries are forced to raise interest rates, the greater the risk that they dump their pegs to the dollar. The results for the US would be unpleasant:
a currency crash and even higher domestic inflation.
Don Kohn, the vice-chairman of the Federal Reserve
believes that the global economic system would function better if emerging economies had a greater degree of monetary independence, allowing them to set the interest rates appropriate for their own economies.
Chairman Ben S. Bernanke: Outstanding Issues in the Analysis of Inflation
FT June 26 2008
How to see world economy through two crises
Martin Wolf, Financial Times, June 24, 2008
Two storms are buffeting the world economy:
an inflationary commodity-price storm and
a deflationary financial one.
Last week I argued that exchange-rate regimes were a link between these distinct events.
The financial crisis was an avoidable stupidity.
Rising prices of energy are a bitter reality.
Our civilisation is based on fossil fuel. But since the end of 2001, the real price of oil has risen some six-fold.
Today, the real price is higher than since the beginning of the previous century.
As the World Bank notes in its Global Development Finance 2008, global oil supply stagnated in 2007.
As I argued last week, global monetary policy is probably too loose,
despite the adverse impact of the credit crisis on high-income countries.
If, as seems likely, the world economy cannot grow as fast as people hoped only a year or two ago, emerging economies have to be part of the adjustment.
In the short term, the biggest monetary policy requirement is a tightening in emerging economies, many of which now have strongly negative real interest rates.
A precondition for such a tightening is a relaxation of exchange rate targeting.
Comment by Rolf Englund:
"relaxation of exchange rate targeting" is code, I guess, for more of freely floating exchange rates
i.e. a further dollar fall vs the currency of China and the Euro.
If a relaxation of exchange rate targeting is part of the solution, then exchange rate targeting must have been part of the problem. That reinforces my view that fixed exchange rates always and everywhere is a bad thing, like in 1992, in UK and in Sweden.
Don Kohn, the vice-chairman of the Federal Reserve
believes that the global economic system would function better if emerging economies had a greater degree of monetary independence, allowing them to set the interest rates appropriate for their own economies.
Chairman Ben S. Bernanke: Outstanding Issues in the Analysis of Inflation
FT June 26 2008
Mr Kohn said “in those countries where strong commodity demands are associated with rapid growth in aggregate demand that outstrips potential supply, actions to contain inflation by restraining aggregate demand would contribute to global price stability”.
These remarks reflect Fed frustration at the way in which fixed exchange rate regimes transmit low interest rates meant to address US economic weakness to rapidly growing emerging economies – fuelling demand for commodities.
In a speech earlier this month, chairman Ben Bernanke asked “does the link between global growth and commodity prices imply a role for global slack, along with domestic slack, in the Phillips curve?”
Vice Chairman Donald L. Kohn
At the International Research Forum on Monetary Policy, Frankfurt, Germany
June 26, 2008
Chairman Ben S. Bernanke
Outstanding Issues in the Analysis of Inflation
June 9, 2008