Federal Reserve Bank of Dallas President Richard Fisher thinks inflation is “too high.” Nonetheless, he’s “comfortable” with the current Fed funds rate, he said yesterday at a conference. But he noted too that the Fed is prepared to hike rates if the central bank’s strategy doesn’t show results in paring the upward move in inflation of late.
This strategy includes expecting that a slowing economy will take the edge off of inflationary momentum (a notion that monetarists dispute). Still, Fed Chairman Ben Bernanke has said as much, and Fisher reiterated the notion yesterday. Of course, nothing is perfect when it comes to monetary policy, and the risk of error is always lurking.
Since the Fed’s birth in 1913, the institution has made more than a few mistakes in misjudging inflation and its capacity for circumventing the best-laid plans of central bankers. But the bad old days are gone, we’re told; the Fed is a far-more enlightened entity in the 21st century.
Let’s hope so, as the stakes aren’t getting any smaller, at least not yet. As last month’s World Economic Outlook from the IMF reminds, it’s not yet clear that inflation has lost its penchant for rising, albeit from unusually low levels from a few years back.
Consider two charts from the IMF report, republished below. The first one reminds that while inflation overall is still low relative to the past 20 years, by 21st century standards pricing pressure is moving up. Labor costs are beginning to move upward too. Will the combination force the Fed to begin raising rates again? Perhaps. It all depends on the data, of course.

Source: IMF World Economic Outlook, Sep 2006
In fact, Fisher reminded that while the housing market is cooling, the rest of the economy appears to be doing just fine. “With a decline in housing market activity, you will dent but not destroy consumer confidence,” he said, via The Wall Street Journal. “I don’t think it will lead to a recession.” For those who subscribe to the Fed’s belief that a slowing economy will nip inflation in the bud, Fisher’s outlook raises questions about the future for monetary policy.
In any case, bond traders have started rethinking (again) the yield on the benchmark 10-year Treasury. Selling in the last two trading sessions has boosted the 10-year’s yield to around 4.75% at yesterday’s close, up from last Thursday’s 4.57%.
But if there’s any fear of another rate hike at the next FOMC meeting on October 24/25, it’s not showing up in Fed funds futures. Trading in the November contract remains placid, anticipating Fed funds will remain unchanged at 5.25% at the monetary confab later this month.
Overall, optimism and tranquility reign supreme on the monetary front. Even stock market volatility, measured by the VIX, is near its lowest levels of recent years. Betting on whether the serenity continues or not is the great wager du jour. Speaking of which, what’s the old saw about the calm before the storm?