More Fed policy chatter ...

Great story at Bloomberg about the dilemma the Fed faces as it heads into this week's meeting. It largely mirrors some thoughts I shared late last week. Here's an excerpt:

"Federal Reserve Chairman Ben S. Bernanke may have to start talking and acting more like Paul Volcker if he wants to avoid being remembered as another Arthur Burns.

"With oil and food prices surging, Volcker told the Economic Club of New York on April 9 that 'there are some resemblances between the present situation and the period in the early 1970s,' when then-Fed Chairman Burns let an inflation psychology take hold. 'here was some fear of recession, the oil price went skyrocketing up, the dollar was very weak.'

"It took Volcker's effort as Fed chief to push the overnight lending rate to 20 percent in 1980 and drive the economy into its deepest decline since the Depression to break the inflation he inherited. To avoid squandering the gains Volcker made, Bernanke may need to stop his all-out effort to prop up the weakening economy and start paying more attention to countering price pressures.

"'You have to take the risk of the possibility of a small recession if you want to avoid ending up with a big one,' says Allan Meltzer, a Fed historian and professor at Carnegie Mellon University in Pittsburgh.

"As policy makers meet this week to decide on interest rates, Bernanke has one big thing going for him that Volcker, 80, didn't: Polls show Americans, for the most part, are still convinced the Fed will do what it takes to keep inflation down.

"That may become a self-fulfilling prophecy, as workers refrain from demanding big wage increases they don't think they'll get, and companies limit price increases for fear of losing sales.

"Consumers expect inflation to average 3.2 percent during the next five to 10 years, according to a Reuters/University of Michigan survey this month. That compares with the 9.7 percent long-run inflation rate they expected in February 1980, seven months after Volcker took office."

And here's some more commentary from a Reuters story, largely on the same topic:

"If the U.S. Federal Reserve Board wants to restrain oil and food prices and help downtrodden consumers, the best thing it can do is stop cutting interest rates.

"That is the view emerging on Wall Street, among some economists, and even a handful of Fed officials who worry that the world economy is getting only limited benefit from deep rate cuts, but all of the unwanted side effects.

"Ending the string of rate reductions that began in September would be welcome news for the European Central Bank, which has held borrowing costs steady while its U.S. counterpart cut, driving the euro to a record high.

"Stopping the rate cuts may also be good for developing countries struggling to pay for increasingly expensive food and fuel, and for rich nations worried about inflation eroding economic growth."

A money quote I can't help pulling out?

"'As central banks pump in liquidity to help bail out the financials, the result so far seems to be ever higher commodity prices,'" said Andrew Lapthorne, an analyst with Société Générale in London."

Meanwhile, with regards to the whole "negative real interest rates" discussion, I thought I would share this chart I put together. It computes the real (inflation-adjusted) level of the federal funds rate, using three different measures of inflation (the year-over-year change in import prices, in PPI, and in CPI). You can see that rates are negative no matter which indicator you use. Negative real rates are inflationary/expansionary, and I fully believe they are exacerbating the commodity price rise. In other words, the Fed is accommodating price increases, rather than fighting them.