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Posted by warren mosler (65.113.90.26) on 10:37:26 11/07/07
let me add something about the fed statement that risks are balanced
between risks to inflation and growth.
the statement mixes metaphors. mainstream economics says long term
growth and employment is a supply side issue, and low inflation is a
NECESSARY condition for optimal long term growth and employment.
That means if keeping inflation causes growth to suffer near term, so
be it, as the benefits of optimal long term growth far out weigh any
short term setbacks. Said another way, the cost of reeling in
inflation later is far higher than the cost of a recession today.
so, as a point of logic, if there is any inflation risk, that risk per
se is an equal risk to long term growth and employment.
So the idea of some kind of balance of risks between inflation and
near term economic performance is way out of mainstream theoretical
foundations.
Mishkin just now said Fed must act to make sure oil prices don't
elevate inflation.
We may have reached the Fed's inflation tolerance level.
He also just repeated that the best guess for oil prices is down.
that's because they believe the prices in the futures market reflect
consensus market expectations. Unfortunately they have failed to
recognize that the term structure of futures contracts for non
perishables is a reflection of carry and storage charges and supply
conditions. For example, if any commodity gets in short supply in the
spot market the futures will be lower than spot. So to assume that
commodity is going to fall in price is an assumption that a supply
shortage is going to cause a fall in price, which of course won't
happen unless supply conditions change. And even if it were perfectly
clear and discounted that supply conditions would stay tight forever
and never change, the 'backwardation' would still persist
indefinitely, as the markets put a premium on physical possession for
immediate use.
What this all means is the Fed plugs in the futures prices for crude
oil and gasoline into its models, and the models use this info for
their inflation projections. So if they assume spot prices are
already 'digested' in current inflation numbers, futures prices for
crude that go down at a 10% annual rate for 08 are a deflationary bias
in the Fed's inflation models.
Note that back when crude was in contango there was much more talk
from the Fed about inflation risks.
Until they sort this out their forward looking models may never show
an inflation risk while commodities are in relatively short supply.
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