Is Kohn Looking to Outsource Global Inflation Fight?

Six-thirty the morning after an FOMC meeting is an unusual time for a top Federal Reserve official to break new ground on monetary policy. But Fed Vice Chairman Donald Kohn did just that Thursday, suggesting that it may be up to central banks in developing countries, and not necessarily those in industrialized economies like the U.S., to take actions to reduce global inflation.

Kohn

“The upward trend in prices of food and energy over the past several years…importantly reflects the pressures posed by rapidly growing demand in developing economies against relatively inelastic global supplies of commodities,” Kohn told a monetary conference in Frankfurt.

And “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,” he said.

To be sure, Kohn doesn’t just single out developing countries in the fight against inflation. “Policymakers around the world must monitor the situation carefully for signs that the increases in relative prices globally do not generate persistently higher inflation,” Kohn said.

But at a time when the world is looking for central-bank leadership in addressing energy and commodity prices, many of which are priced in U.S. dollars, Kohn appeared to outsource that role to emerging-market countries.

Another implication of his remarks is that Fed officials, who on Wednesday left interest rates unchanged after seven-straight reductions, may not think higher rates in the U.S. would necessarily do much good unless action is taken in smaller economies.

“The fact that Kohn is looking for foreign central banks to help relieve the U.S. inflation problem may be taken as an indication of some reluctance toward domestically taking actions to restrain inflation,” J.P. Morgan economist Michael Feroli said in a research note.

This isn’t the first not-our-fault themed set of remarks by the Fed’s No. 2. Last month, Kohn pushed back against the notion that the Fed’s aggressive rate-cut cycle led to higher global prices for commodities.

Some “commentators,” he said on May 20, “have cited the actions of the Federal Reserve in reducing interest rates as an important consideration boosting commodity prices.”

“To be sure, commodity prices did rise as interest rates fell,” Kohn added, “however, for many commodities, inventories have fallen to all-time lows, a development that casts doubt on the premise that speculative demand boosted by low interest rates has pushed prices above levels that would be consistent with the fundamentals of supply and demand.”

So lower interest rates and the falling dollar “may have played a role in the rise in the prices of oil and other commodities, but it probably has been a small one,” Kohn said.

Kohn’s latest remarks do reflect a dilemma for Fed policymakers. The U.S. slowdown, in theory, should be bringing down inflation as the economy uses fewer labor and other resources. And ongoing strains in U.S. financial markets — evidenced by the latest tumble in equity markets — as well as weak housing and rising unemployment make it hard to envision higher rates by the Fed.

But while the slowdown appears to be keeping wage costs under control, headline inflation now tops 4% on an annual basis based on the consumer price index. It should approach or exceed 5% once recent oil-price gains are fully reflected in the data.

Yet the danger in Kohn’s remarks is that they may imply a certain helplessness on the part of the Fed. After all, under Kohn’s apparent reasoning, even if the Fed were to raise interest rates, any effect on inflation might be muted if central banks in developing countries don’t follow suit.

And that perception could make things even worse for the Fed. If global investors lose even more confidence that the Fed can bring down inflation, then it might spur still more investment into commodities as an inflation hedge, pushing their prices even higher.

Because even if Kohn would like the spotlight to shine elsewhere, the reality is that when it comes to energy and commodity prices these days, it shines most brightly on the Fed. –Brian Blackstone