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October 07, 2005
Central Bankers Talking Tough
Mark Thoma and William Polley have been doing a fine job of documenting the hawkish sentiments coming from Federal Reserve officials in the past week: from Dallas president Richard Fisher (here and here), from Philadelphia president Anthony Santomero (here), from Kansas City president Thomas Hoenig (here), from St. Louis president William Poole and President Fisher again (here, here, and here). In today's Wall street Journal (page A1 of the print edition), E.S. Browning takes notice of the "whiff of inflation" in the air prompting these comments from the Fed and raising expectations that the Federal Open Market Committee will "try to cool the economy by pushing interest rates higher, raising borrowing costs for businesses and consumers alike."
It's not just the Fed talking tough, though. From Reuters:'
European Central Bank President Jean-Claude Trichet toughened his anti-inflation warnings on Thursday, saying strong vigilance is essential and the ECB stands ready to raise interest rates should problems worsen.
The Governing Council did discuss raising ECB interest rates but decided that the current 2 percent level "still remains appropriate."
"At the same time, strong vigilance with regard to upside risks to price stability is warranted. It is essential that the increase in the current inflation rate does not translate into higher underlying inflationary pressures," Trichet said.
Financial markets viewed the shift to strong vigilance from particular vigilance a month earlier as confirmation of its recent position that the ECB will start tightening interest rates in the first half of next year.
Here's an interesting question: How comparable are the current positions of ECB and the Federal Reserve? Does it matter that the policy rate in the eurozone is 175 basis points lower than the federal funds rate?
Maybe. Here, courtesy of the Erasmus School of Economics in Rotterdam, is a graph of the euro policy rate, along with various benchmark Taylor rule prescriptions:
This contrasts pretty clearly with what a similar (though not identical) calculation implies for the U.S. Here is a picture of the federal funds rate (just prior to the last rate hike in September) and some Taylor rule benchmarks from the last edition of the Cleveland Fed's Economic Trends:
Despite some differences in details, both sets of Taylor rule calculations tell a pretty consistent story: An inflation target somewhere in the neighborhood of 1.5% to 2% implies a policy rate somewhere in the neighborhood of 4%.
You may not want to take these benchmarks for more than what they are -- useful guideposts among the many other pieces of information that help guide monetary policy decisions. But they do raise two obvious questions: How long can the ECB hold firm on rates, and how far does the Fed have to go?
UPDATE: The Prudent Investor notes the Hoenig and Fisher comments, and adds the Bank of England's announcement that it is standing pat for now to his report on the ECB rate decision. The Skeptical Speculator notes that both the BoE and ECB decisions were taken in the context of some fairly weak forecasts for near-term economic growth.
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Fed talks tough on inflation
The Federal Reserve raised rates in September, and will do so again at its next meeting on 1 November. I set out my reasons for expecting the FOMC to keep raising rates some time ago. Add to that the hawkish comments from Fed officials that Mark Thoma ... [Read More]
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