Lately, many people are hearing an echo — faintly perhaps but distinctly audible — of the stagflation of the 1970s. Even as economic growth sags, oil and gasoline prices are surging to new heights. Gold is on the rise, along with prices of such basic commodities as wheat and steel. And on Wednesday, with the latest US government report on consumer prices, there are signs that overall inflation, after years of only modest increases, may be breaking out of its box.For the US Federal Reserve and its chairman, Ben S Bernanke, all this could not come at a worse time. With the credit markets in disarray from the collapse of the housing bubble, Bernanke is cutting rates in a headlong rush to blunt the risks of recession. But in putting its emphasis above all on reviving growth, America’s central bank, according to some economists and even a few Fed officials, may face a bigger inflation problem down the road. “They are cutting rates with a bill to be paid later,” said John Ryding, chief US economist at Bear Stearns. “The question is not, will we get inflation, but how much will it cost to stuff the genie back in the bottle. This has the feel of 1970s stagflation.”Over the last 12 months, US consumer prices are up 4.3 per cent on average. The core index of US consumer price inflation, which excludes food and oil, was 2.5 per cent higher in January than a year earlier, significantly above the Fed’s unofficial comfort zone of a 1 to 2 per cent underlying inflation rate. That’s a far cry from the double-digit inflation rates that battered the economy at times in the 1970s, but still worrisome. Analysts like Ryding say that by tolerating such price rises and maybe even allowing them to escalate, the Federal Reserve is risking its hard-won credibility as an inflation fighter, which will ultimately require it to push up interest rates higher than otherwise to contain the damage.Economists expect the Fed’s policy-making committee to cut interest rates again when it meets on March 18, engineering its sixth reduction since September. But fears of a revival of inflation underline the difficult decisions it now faces. Like the Fed, economists generally remain more concerned about the immediate threat of recession than the more distant fear of higher inflation. Recent data suggests an economy that may be in a downturn or close to it. The consensus is that the expected slowdown is likely to create enough spare capacity to suck inflationary pressures out of the US economy.Moreover, even if some additional inflation is a side effect of the Fed’s prescription, many economists say, it sure beats the alternative. Once interest rate cuts have nursed US economy through the next few difficult quarters, they say, the Fed can easily raise rates again to respond to any pick-up in inflation. “They are going to fix the wound,” said David Durst, chief investment strategist of Global Wealth Management Group of Morgan Stanley. “They are going to take care of growth situation and fight inflation when the economy gets stronger.”
