Economics: Why The Fed Has To Fight Inflation Before It Starts

(Drivebycuriosity) - I think that the Fed has to hike her interest rate now. Many commentators are against a hike because they believe that the global economy is too weak and there is no inflation. But I think that an extremely accommodative monetary policy with interest rates close to zero doesn´t fit to the continuous economic expansion (solid US job markets and a recovering European economy  driveby) and could start inflation in the coming years.

Yes, there is no inflation - yet. The basic (core) inflation rate (rents, medical & other services) hovers around 1.8% (ycharts). But rents & health costs are already rising sharply. The headline inflation rate (plus 0.2% trading) is restrained for the moment because oil and other commodity prices tumbled sharply since last year. But inflation could come back soon if commodity prices climb again. The fierce oil price rally in August (plus 27%) was a warning and a reminder to 2009 as low interest rates combined with QE kickstarted a massive oil price speculation. From spring 2009 to 2012 the price of oil tripled from $40 to $120 even in weak economic environment, financed by a supper accommodative monetary policy. Hedge funds and others speculators borrowed cheap money and pumped the liquidity into the oil market by purchasing oil futures on the financial markets.

The current massive price dampening effect from cheaper commodities could disappear in 2016. Then the statistics will compare prices with oil at $50 and gasoline at $2.40. If commodity prices recover in 2006 then their climbing prices would add onto the inflation rate.

History shows that many recessions occurred when the central bank responded too late to rising prices. In these cases the Fed had to break an already cumulating inflation mentality with drastic measures. Sharply rising interest rates then shocked the economy into a recession.

Now the Fed has the chance to adapt interest rates gradually to the economic expansion. An interest rate hike of just 0.25%-points next week could be a begin. A gradually and well tempered raise over the coming year would bring back interest rates to a normal level and avoid a shock treatment.

I wish that Janet Yellen & Co. will have the courage and discretion for this step.