Recession Watch: Oil, Inflation, the Fed

Here's what policymakers, economists, and strategists have to say about the impact of $133 oil on inflation, growth, and Fed policy

Oil prices reached nosebleed territory on May 21, moving above $133 per barrel in New York trading—on the same day that Federal Reserve officials expressed growing concern about inflation. Here's a roundup of what policymakers, economists, and strategists had to say about oil, inflation, growth, and interest rates on May 21, as compiled by BusinessWeek.com, S&P MarketScope, and Action Economics:

The Fed's Inflation Worries

From Action Economics: The minutes from the Apr. 29-30 Federal Reserve policy meeting showed the expected upward shift in inflation expectations and unemployment, while the Fed downgraded its outlook on growth. Most officials viewed the April rate cut as a "close call," and several members noted "it was unlikely to be appropriate to ease policy in response to information suggesting that the economy was slowing further, or even contracting in the near term" (but that was already suggested by the dissents from Philadelphia Fed President Charles Plosser and Dallas Fed President Richard Fisher).

It was still the case that "most" members still saw downside risks to growth, with "many" officials expecting a contraction in gross domestic product in the first half of the year. However, a rebound was expected in the second half of the year and in 2009.

The minutes are consistent with the view the Fed is on hold for now, but didn't suggest rate hikes are in the picture at all.

Warsh Suggests the Fed Is on Hold

From S&P MarketScope: Fed Governor Kevin Warsh warned that the policy-setting Federal Open Market Committee has used its traditional blunt tool or "hammer" of rate cuts with considerable force over the past nine months and it needs to resist the impulse to bang rates down again. "Even if the economy were to weaken somewhat further, we should be inclined to resist expected, reflexive calls to trot out the hammer again," he said in prepared remarks to the Exchequer Club in Washington. Instead, the Fed needs to reinforce the idea that "further hammering needs to be done, but it needs to be accomplished by the financial institutions themselves in retooling their businesses," Warsh said. That includes raising substantial capital, changing business models, and other efforts to improve financial market functioning.

"If the Fed were deemed too accommodative for too long, credibility could be undermined," Warsh said. "The public could mistakenly see the stance of policy as a sign that our commitment to long-term price stability has wavered. That is not a perception we will countenance," he said. "If abundant credit availability is perpetuated by investor overconfidence, I would submit, policymakers may need to target a higher federal funds rate than otherwise to help the economy attain a sustainable equilibrium. The changes of credit availability during the past six years have less to do with the prevailing stance of policy and more to do with changes in financial markets and financial intermediaries," he said.