No fun at the Federal Reserve

Inflation up, housing down. Ben Bernanke has a hard job.

Andrew Leonard
May 18, 2006 12:02AM (UTC)

The Dow Jones Industrial Average plunged more than 200 points today, as rising prices for consumer goods convinced Wall Street that the Federal Reserve will continue to raise interest rates, instead of, as many analysts were predicting, calling a halt at its next meeting.

This puts Ben Bernanke, the new Federal Reserve chairman, in quite a pickle. You can make a good argument that the Fed's prime rate hikes have been a significant factor in popping the housing bubble. The connection between rising mortgage rates and the Fed isn't absolutely direct, but there's some correlation. The Fed has been putting the squeeze on the economy to hold off inflation -- one major side effect has been a significant slowdown in the long-running real estate boom. (Yesterday's news that home builders built the fewest new homes in two years in April was just the latest data point.)


For months Wall Street has been wondering when the Fed would finally stop its metronomic-like rate boosts. Bernanke has been sending mixed signals since he's been on the job: The most anyone has been able to glean is the entirely sensible "We'll do what the economy tells us we need to do."

But the latest numbers on consumer prices are disturbing. For years, economists have been wondering when the surge in oil prices would finally begin to make its presence felt in the overall economy. Some have speculated that the efficiencies built into globalization, that is, low-priced goods from China, have kept inflation in check. But sooner or later, $70-dollar-a-barrel oil prices had to take their toll.

But if the Fed decides to continue to raise the prime rate to combat the new dangers of inflation, won't that further accelerate the housing slowdown? And if, as many economists have suggested, home equity loans and exotic mortgage instruments have been financing the seemingly inexhaustible American consumption boom, isn't it possible that by defending against inflation, the Fed will do even more damage to one of the main supporting legs of the global economy?


To make matters worse, new reports on Chinese labor shortages have some experts suggesting that China's low-cost leader days may be numbered. So what happens if globalization's built-in inflation check also starts to falter?

Just a few weeks ago, the business press was chortling over surprisingly high economic growth numbers for the first quarter of 2006. It's never a good idea to make long-range forecasts based on a short-term wobble in the Dow, but suddenly, the outlook doesn't seem quite so rosy.

Andrew Leonard

Andrew Leonard is a staff writer at Salon. On Twitter, @koxinga21.

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