NEWS / Foreign Exchange

Mishkin Remains Concerned About Inflation

Governor Mishkin??™s outlook for the U.S. economy was marked with observations about the housing market, capital spending, inflation expectations, and credibility of a central bank. In his opinion, the two main sources of risk to economic growth are the housing market and capital spending.

With regard to the housing market, Governor Mishkin is of the opinion ???that cutbacks in new residential construction may well persist for a while.??? The problems with the sub-prime market were presented as a source of additional risk in the housing market but were not depicted as a source of contagion that would cause problems in other areas of the mortgage market and the economy.

The second source of concern according to Mishkin is capital spending. Capital spending has declined in the second and fourth quarters of 2006.

Recent information about orders and shipments of non-defense capital goods supports Mishkin??™s view. The durable goods orders report of March, to be published on April 25, should offer some new insights about capital spending. Without doubt, capital spending is on the watch list of the Fed.

Reiterating Mishkin??™s remarks, ???prospects for housing and business spending appear to have widened the range of uncertainty about the near-term outlook.???

Mishkin??™s comments about inflation expectations and credibility of the central bank suggest that he is most likely to vote with many others of the FOMC for waiting until core inflation readings are below 2.0% before implementing an easier monetary policy. Here is the excerpt about inflation expectations and credibility of central bank.

???Although I believe that inflation expectations will play a primary role in determining the course of inflation, I want to emphasize that neither economists nor policymakers understand the expectations-formation process very well. However, one aspect of expectations formation that we have come to regard as crucial is the credibility of monetary policy. Consistent with its dual mandate to foster maximum sustainable employment and price stability, the Fed must therefore continue to respond aggressively to shocks that have potentially persistent adverse effects on both inflation and real activity. And we need to monitor long-run inflation expectations closely to avoid losing credibility with the markets.???

???I recognize that uncertainties surrounding the economic outlook have increased recently, and I remain concerned that the persistence of inflation at the recent elevated rate could have adverse consequences for economic performance.???

In conclusion, inflation is the Fed??™s predominant concern. Risks to economic growth are now vying for equal importance with inflation but they are taking a slightly lower spot in the priority list.