Federal Reserve Vice Chairman Donald Kohn said on Thursday that rising energy and food prices have hit headline inflation, but this has only seeped into inflation expectations by a little bit so far.
"For the moment, higher headline rates of inflation have shown only a few tentative signs of embedding themselves in core inflation or longer-term inflation expectations," he said in remarks released in advance to the media in Washington.
"However, policymakers around the world must monitor the situation carefully for signs that the increases in relative prices globally do not generate persistently higher inflation," he said in the text of a speech to be delivered to the International Research Forum on Monetary Policy in Frankfurt.
Kohn was to speak the day after the Federal Reserve held interest rates unchanged at 2 percent while escalating its warnings on inflation. Investors took this as a clear signal that its next rate move would be up.
His speech was mainly about economic decoupling between the United States -- where a collapse in the housing sector has chilled growth -- and the rest of the world, where activity has held up better. Kohn cautioned that the jury was still out.
"We are still in the midst of the current episode. Financial markets remain stressed; housing markets in many countries are adjusting after a sharp run-up in prices; and the effects of the turmoil on economic activity in the United States and elsewhere are still working themselves out.
"Accordingly, it is too early to tell how correlated U.S. and foreign activity will have been in this period," he said.
Kohn noted that the clear global downturn in the period after the collapse of the technology bubble in 2000-2001 might owe something to the international nature of that market.
Housing, on the other hand, is produced from local inputs and generates outputs that are not traded internationally.
While the evidence of the linkages between national business cycles might not stand up to close empirical scrutiny, Kohn said there was no doubt that higher energy and food prices were impacting inflation at a global level. But he was at a loss to explain why prices continued to surge.
"The reasons for the trajectory and persistence of increases in prices of food and energy this year, as global growth has moderated, are not entirely clear," he said.
He said that stronger earnings for commodity-exporting countries, thanks to higher commodity prices, may have helped shield these countries from the U.S. slowdown and account for the resilience of emerging market growth so far.
But these countries should not ignore economic overheating linked to the commodity boom, since this could have global ramifications, Kohn warned.
"In those countries where strong commodity demands are associated with rapid growth in aggregate demand that outstrips potential supply, actions to contain inflation by restraining aggregate demand would contribute to global price stability."
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