Tags: Stanford | McKinnon | Fed | stagflation | stagnant | growth | high

Stanford's McKinnon: Fed Bringing Back Stagflation

Wednesday, 25 May 2011 08:35 AM

Ronald McKinnon, a senior fellow at the Stanford Institution for Economic Policy Research, says the Federal Reserve is bringing back the bad old days: 1970s-style stagflation, or combination of stagnant growth and high inflation.

Although many forces buffet the U.S. economy, “the near-zero interest rate policy of the Federal Reserve is the prime contributor to the current bout with stagflation," McKinnon writes in The Wall Street Journal.

Wanting to avoid sharp appreciations of their currencies and losses in international competitiveness, many Asian and Latin American central banks intervened to buy dollars with domestic base monies and lost monetary control, McKinnon notes.

"This caused a surge in consumer price index (CPI) inflation of more than 5 percent in major emerging markets such as China, Brazil and Indonesia, with the dollar prices of primary commodities rising more than 40 percent worldwide over the past year," he says.

"So the proximate cause of the rise in U.S. prices is inflation in emerging markets, but its true origin is in Washington."

Since 1945, most of the world has been on a dollar standard, McKinnon notes.

bullard.jpg
Fed's James Bullard
(Federal Reserve Bank of St. Louis photo)
However, to avoid conflict in targeting exchange rates, the rule of the game is that the U.S. remains passive without an exchange-rate objective of its own.

Lacking an exchange-rate constraint, “the Fed can conduct a more independent monetary policy than other central banks can,” says McKinnon.

“How it chooses to exercise this independence is crucial to the stability of the international monetary system as a whole.”

Reuters reports that turmoil over sovereign debt problems in Europe could weigh on the U.S. economic recovery, according to St. Louis Federal Reserve President James Bullard.

"I am concerned about the situation in Europe," Bullard told reporters after a speech. "Prolonged financial market turmoil could be a negative for the U.S."

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Ronald McKinnon, a senior fellow at the Stanford Institution for Economic Policy Research, says the Federal Reserve is bringing back the bad old days: 1970s-style stagflation, or combination of stagnant growth and high inflation. Although many forces buffet the U.S....
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