Forget About the Fed Meeting This Week

The Federal Reserve will hold interest rates steady at its meeting on Tuesday, August 5, 2008. Doing anything else would only upset the apple cart, and the last thing the Fed needs is apples spilling everywhere. But leaving rates unchanged is a gamble that inflation won't spin out of control. The Fed will express concern about inflation, but words are all the inflation hawks will get from this meeting.

The important date is Thursday, August 14, 2008. That's when the Bureau of Labor Statistics will release the July 2008 Consumer Price Index figures. The critical question is whether rising energy and food prices have filtered more broadly into consumer prices, causing widespread increases. This "cost-push" inflation would be the Fed's worst nightmare. Cost-push inflation is difficult to contain, except by raising interest rates and forcing the economy into a nasty recession. Maybe we're in a recession now, but the kind needed to shut down cost-push inflation is much worse.

The grinding and ever-increasing inflation of the 1970s was of the cost-push variety, and was halted only by a recession in the early 1980s that drove unemployment above 10% (we're at 5.7% now). The cost-push in the 1970s came from wage increases that pushed up the prices of products and services, which in turn pushed wage demands even higher. Workers today don't have the labor unions and other market power to extract similar wage increases. But energy is a component of all goods and services, and its rising costs are ubiquitous. Businesses face growing pressure to raise prices to cover energy expenses (and sometimes to subsidize employee commuting costs). Some economists argue that the economic slowdown will constrain price increases. Perhaps so to some degree, but many businesses are past the point of being able to absorb more cost increases. Either they raise prices or they go under (the airlines serve as Exhibit A in this regard). And if they go under, their competitors will have more room to raise prices. Cost-push inflation is becoming a real danger, and could push the Fed farther back into the corner. Next week, we'll know more.