Fed Faces Foreign-Policy Dilemma on Rates
Factors Outside U.S. Complicate Central Bank’s Decision on Raising Rates
By Justin Lahart
March 1, 2015 3:43 p.m. ET
The Port of Los Angeles. Morgan Stanley estimates that Monday’s report on consumer prices from the Commerce Department will show that they fell 0.5% in January from a month earlier, putting them 0.1% higher year over year. Photo: Associated Press Prices in America face a stiff offshore breeze—complicating the Federal Reserve’s decisions on interest rates.
Even as the U.S. economy has picked up speed and unemployment has fallen, inflation has been remarkably cool. Morgan Stanley estimates that Monday’s report on consumer prices from the Commerce Department will show that they fell 0.5% in January from a month earlier, putting them 0.1% higher year over year. Much of that weakness was due to lower gasoline prices. But the bank estimates that core prices, which exclude food and energy, were flat in January, putting them just 1.2% above the year-earlier level.
Low oil prices likely are having some effect on core prices. Manufacturers’ fuel tabs are lower, for example, and the cost to ship goods has also fallen. The dollar, which on a trade-weighted basis last month was 10% higher against other currencies, year over year, also plays a role by driving down the cost of imports.
The effects of both oil and the dollar can be seen as transitory. If they merely stabilize, their effect on inflation will be neutralized. But it is also important to remember that what has happened with both of them result from weakness outside the U.S. The global economy isn’t growing rapidly enough relative to the supply that has been put in place in recent years to push prices higher. Hence, core inflation isn’t low just in the U.S., but all over the world.
Moreover, low prices abroad have a more pronounced effect on prices within the U.S. than they did in the past. That is because trade plays a much bigger role in the economy. Last year, the combined value of U.S. imports and exports was $5.2 trillion, an amount equal to 30% of gross domestic product. That compares with 25% in 2000 and 20% in 1990.
Indeed, the riddle of why core inflation didn’t fall as much when there was high unemployment after the recession may be partly explained by the fact that, with the dollar weak and China booming, import prices picked up.
Recent research from University of Chicago economists Martin Beraja, Erik Hurst and Juan Ospina shows that areas of the U.S. that saw the biggest increases in unemployment also saw prices for nontradable goods—items that include a lot of local costs—come under pressure while tradable goods prices held up better. If that happened at the local level, perhaps it also did at the national level too, with import costs buoying prices overall.
For the Fed, the cooling effect of low overseas inflation poses two problems: The first is that it is hard to measure confidently how much of what is going on with prices comes from overseas and how much is home brewed. The second is that just because prices might be higher if it wasn’t for influences from overseas, that might not make a compelling argument for taking a tighter stance on monetary policy.
Prices may have to show some sign that they are pushing through the overseas headwind, or those will have to subside, before the Fed starts raising rates.
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