Fall in US inflation reminds Fed has been reactive

By Edward Harrison On Oct 16, 2008

Inflation was unchanged from the previous month in September, bringing the annual rate of inflation down to 4.9%. While the inflation rate is still elevated, the drop in oil and commodity prices combined with lower consumer spending is likely to bring this rate down even further in 2009.

The continued decrease in inflation highlights how reactive monetary authorities have been. Last month, I said that I expected inflation to fall and I also expected that to give the Federal Reserve an excuse to cut interest rates, all of which is true. But The Fed did not cut rates on the 16th of September when it met, despite obvious signs of panic in the markets. The Fed has since cut base rates to 1.5% as the panic continued, confirming for me that the Fed has been reactive and behind the curve throughout this crisis.

Yesterday, Ben Bernanke held a talk in which he claimed that the Fed has made appropriate and large monetary policy changes to fight the crisis. I would argue that the Federal Reserve and the Treasury have been blinded by an ideological bias to “laissez-fire” free markets and have, therefore, failed to recognize the extent of the crisis we have had. Up until Lehman failed and financial markets panicked, the monetary authorities both in the U.S> and in Europe took a reactive, adhoc approach to monetary policy and we have paid the price fo that in market volatility.

Ben Bernanke claims he is a student of the Great Depression and this holds him in good stead for reacting to a crisis like the one we are now experiencing. However, to my mind, the U.S. monetary authorities were asleep at the wheel, while economic analysts like myself have been warning until we were blue in the face that a systemic response was necessary.