The Hindu Business Line : Stagflation risk poses dilemma for Greenspan

AN `S' word threatens to replace the dreaded `R' word. `R', of course, stands for recession. `S' is the new addition, representing `stagflation'. And stagflation is a far worse state to be in than recession.

Why? Any central banker would tell you. Cutting interest rates and increasing fiscal spending can tackle recession. But how does one handle stagflation, which is a combination of no growth and rising inflation? If you increase interest rates, you risk recession and if you reduce them, you risk more inflation.

The possibility of `stagflation' has suddenly started to haunt the US economy and policymakers. The provocation is the recent rash of data, suggesting a slowdown. First quarter GDP grew at 3.1 per cent (annualised) - less than forecasts of 3.5 per cent and more. Consumer and business spending fell, trade gap increased and a chunk of the increase in GDP was actually due to inventory buildups - not a good sign.

Meanwhile, the indices of business and consumer confidence have deteriorated. Both the University of Michigan and Conference Board indicators on the latter declined. The ISM index, measuring manufacturing sector sentiment and outlook, too fell.

Job growth continues to be tardy. Last month's payroll addition was just 1,10,000 - far below the average figures in previous economic cycles. Meanwhile, spiralling energy prices (and perhaps better pricing power for producers and businesses) have pushed up core inflation (i.e., inflation stripped of food and energy), month-to-month, to 0.3 per cent, by whichever measure you choose - CPI or Personal Consumption Expenditure . If this holds, the inflation rate will approach four per cent - a sharp rise from the sub-2 per cent levels of the last few years.

It is in this background that the US interest rate-setting body, the Federal Open Market Committee meets. As one analyst quipped, given the latest batch of data, the Fed is "caught between a rock and a hard place".

Of course, things have not gotten quite that bad yet. Oil has softened from close to $60 to below $50. That should alleviate price pressures and put more discretionary spending money in the pockets of consumers. And it is not as if the economy is in negative territory. The 3.1 per cent is still way above the growth rates of Europe and Japan.

Nevertheless, the FOMC is at the crossroads. The best guess is that they will not shift gears beyond the 25 basis points move in each meeting, since they started raising rates from one per cent.

The post-meeting statement is likely to stick to the goal of keeping the fine balance between growth and inflation risk equal (which means acting in consonance with emerging economic data).

Bonds are likely to be range-bound in the aftermath of the Fed meeting. A breakout is likely only after the directions of the economy, energy prices, stock markets and inflation become clear. But a possible Fed pause in response to a slowing economy means value at the short end of the yield curve.

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Banks to float company for new settlement system

Stagflation risk poses dilemma for Greenspan

Rupee weakens; bond prices rally

SBBJ net lower at Rs 205 crore

SBH annual net drops to Rs 251 cr

LIC targets 48% rise in premium income

LIC to focus on equities, may scale up exposure

Law on microfinance bodies soon

Andhra Bank hopes to double retail lending

IDFC plans to fund more IT parks

APSFC net profit up 30% at Rs 13.15 cr

Govt stock sale oversubscribed