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Inflation Looms!
By Jon Menaster | June 11, 2008
Inflation is always a concern. Nobody likes to have their money devalued. Yet with each passing interest rate cut by the Fed, the inflation rate will increase. Now that the federal funds rate and discount rate are at lows not seen since Greenspan’s attempt in the early 2000s to fix the post-technology bubble, people have started chirping about inflationary concerns. Reacting to those concerns, good ol’ Ben has now started leaking out words which may indicate a shift in the strategy the Federal Reserve will take. In the article “Concerns on Economy Are Shifting to Inflation“, the New York Times illustrates everyone’s attempts to read into each and every word Bernanke says. According to the Times, Bernanke said on Monday night that:
on Monday night that the central bank would “strongly resist an erosion of longer-term inflation expectations,” implying a pause in its rate-cutting campaign and, perhaps, eventual rate increases.
The best part is the use of the term “implying”. Nobody really knows what’s going on in Ben’s head. Only Ben. The media, the pundits, Wall Street, the individual investor, everybody tries to figure out which way the Fed will shift because so much is affected by every move. For instance, bond prices move in the opposite direction of rate movements.
In case you weren’t quite sure exactly how the Fed goes about protecting against inflation by raising rates, here’s a quick primer. Say the Fed sets a new target rate higher than the existing one. To achieve that rate, the Fed will sell securities to banks, who then lose capital but gain securities such as treasuries in exchange. This in turn decreases the supply of money in the economy. With less money in the economy, each dollar is worth more and therefore inflation is slowed somewhat.
The problem is that with less money available to the banks due to the draining of their reserves to buy securities, they cannot lend as much money to consumers and businesses due to reserve requirements (the percentage of banks’ customers deposits which they must hold and cannot lend out - isn’t fractional reserve lending wonderful?). This lowers the availability of money and makes entrepreneurial inclinations harder to fulfill. It also makes it harder for consumers to purchase new homes, and as we already know most banks are being a whole lot more careful about who they lend to. I hope that made sense - I just wanted to give all of you a picture of what a double edged sword trying to stop inflation can be. Good luck Ben!
Topics: Investing, Money News |