Oil gows up becouse dollar is going down. Oil is priced in dollars, and buyers agree to pay higheer price because they know that dollar will be devaluated more in near future. No speculation on price fixing is needed. Besides, it is the first sign of coming inflation.
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All this gives the Fed maneuvering room. Expectations matter; inflation won't burst forth instantly. Even Meltzer doesn't see an immediate surge. "When will it come? Surely not right away," he writes.
Still, his warning remains relevant. The Fed has often overdone expansionary policies and fostered inflationary expectations. In the 1960s and 1970s, that occurred through excess demand and a classic wage-price spiral. The danger now might emerge through exchange rates and commodity prices. Inflation fears could raise prices of commodities (oil, metals) and depress the dollar. Imports would become costlier, allowing domestic producers to raise prices. Once inflationary practices take hold, high inflation and unemployment can coexist: dreaded "stagflation." In 1977, both inflation and unemployment were about 7 percent.
There's evidence (better housing and auto sales, stronger growth in "emerging markets") that the danger of a deflationary economic free fall is ebbing. Someday, the Fed will have to raise interest rates. Fed chairman Ben Bernanke has pledged to preempt high inflation. Will the Fed get the timing right and resist political pressures? Will his pledges reassure markets?
One reason they might not is that Bernanke's term as chairman expires in January. Any replacement named by President Obama would be seen, fairly or not, as more beholden to the administration. The president should eliminate that perception by reappointing Bernanke. That would not settle today's deflation-inflation debate, but it would remove a needless uncertainty.
© 2009
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