No one is ready to guarantee that the US economy is beyond concern, but Federal Reserve Chairman Ben Bernanke and other central bank members have been hinting that inflation is moving to the forefront of policy consideration. A revised first quarter gross domestic product (GDP) to .9 percent growth, up from the previous .6 percent, prompted some hopeful economists to believe Fed rate cuts and other market interventions may have prevented a full-fledged recession.

New data out today (June 3) suggests that credit problems may still be present. Financial services companies may still be in for a bumpy road, despite previous optimistic views express by Bernanke and others. Housing and other economic concerns still weigh on the minds of consumers and bank officials.

However, inflation has been sitting on the heat seat waiting to be addressed. For several months, core inflation readings have been moderately higher than central bank members prefer. The challenge for policy makers has been that addressing inflation effects is somewhat counter to managing a struggling economy. First and foremost, the aggressive Fed rate cuts, which have been used to help spark the economy, are contradictor to rate increases that are commonly used to deal with inflation on its own.

Truthfully, officials have been fortunate that inflation has not become out of control during recent months. As early as late last year, a few leading bank members hinted that too much aggressiveness in rate cuts could overheat inflation. The reality of the economic situation was, however, that rate cuts had to be used to inspire spending, growth, and business expansion.

Bernanke today might have indicated a personal shift in focus. He mentioned that while US turmoil still persists, he has grown more concerned with high prices that have resulted from a devalued dollar. His comments about the dollar come at a time when the greenback is actually substantially off its lows against major currencies. The timing is likely based on the fact that when the dollar was hitting bottom, the Fed Chief’s mind was on a deep economic hole. His change in focus with his public remarks today included indications of an expected improvement in the economy for late 2008.

Most economists agree that a change in central bank mindset from economic growth, to inflation control, likely also means an end in the near-term to rate cuts. Some have speculated for a while that it would not take like for the central bank to quickly undue its aggressive rate cuts to deal with rising consumer prices at the pump and in the grocery store. Because economic effects from rate adjustments often take months to develop, the Fed would probably act quickly to address inflation, if it is comfortable the economy is headed upward.

The central bank meets again June 24-25, and most economists believe rates will be held steady for the first time in several months. A new call for rate increases as early as late 2008 have developed in recent days. Others have suggested that it is better for the Fed to lie low for a while to late the economy grow and to further assess the need for intervention against inflation.

Although a sluggish economy has burdened many Americans, especially with regard to credit and housing, inflation has been, and could become an even more difficult situation. Rate cuts devalue a country’s currency by making it less desirable to foreign and income-based investors who buy high yield currencies by borrowing lower rate currencies. Thus, the drastic moves by the Fed have contributed to the sinking of the dollar. The weak dollar, in turn, has helped drive up costs of consumer products, including gas and groceries, because the currency does not carry as much buying power.

Market Recap

The Dow dropped 133 points on Monday as sellers took control of the new trading week on Wall Street. Tuesday brought nothing better as the Dow dropped another 100 points to close at 12,402. The NASDAQ and S&P were also down 11 and 8 points on Tuesday. Economic data suggesting financial services companies are still struggling burdened the markets. Factory orders increased in April, a pleasant surprise. The dollar has started the week strong despite the equity struggles.

Neil Kokemuller
Tuesday, June 3, 2008
8:18 PM EST

Neil Kokemuller is an Associate Professor of Marketing at Des Moines Area Community College in Des Moines, Iowa, USA. He has a MBA from Iowa State University.

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