If and when inflation strikes, history suggests the assualt’s anything but ambigious. No one debated if inflation was a bonafide menace in the 1970s, to cite the obvious example. But clarity of that sort, either confirming or denying inflation’s presence, may be a luxury in the 21st century. Instead, we can look forward to death by a thousand forecasts, and more than a little uncertainty from the numbers.

Accordingly, the jury’s still out on whether inflation’s a threat at all. Depending on the day, the economic news ebbs and flows, giving aid and comfort to one side of the debate, only to retract the support the next day by way of contradictory data.
After yesterday’s ISM services sector survey for September, the specter of inflation and recession simultaneously—stagflation–has again been cited as a lurking shadow. “Until recently, investors generally assumed that soaring energy prices wouldn’t upset Fed policymakers as long as core inflation remained subdued, which it has until now,” Ed Yardeni, chief investment strategist for Oak Associates, wrote in an email to clients this morning. “Of course, the best way to make sure that energy costs don’t drive up core inflation is to raise interest rates high enough to bring energy prices back down, or at least stop them from going any higher.”
Grappling with the question of whether inflation’s a threat, and what to do about it, if anything, is the new new challenge for central bankers. The European Central Bank is struggling with that question. That stuggle today emerged as a decision to stand pat on interest rates, however. The ECB announced on Thursday that its main refinancing rate will remain at 2.0%, as it has since June 2003. The reasoning is that Europe’s sluggish economy trumps mounting inflationary pressures. Nonetheless, Eurozone inflation in fact rose last month at its fastest pace in more than a year to an annualized rate of 2.5%, up from 2.2% in August. But as the Financial Times today reports. But picking one’s poison is required these days. As such, the ECB chooses to worry that high energy prices will further constrain economic growth on the Continent, thus the verdict to keep interest rates at 2.0%.
The Federal Reserve is faced with a similar set of macroeconomic choices, but comes to a different conclusion. Rather than focusing on an economic slowdown, either real or perceived, the Fed’s intent on fighting the rise in top-line inflation, and so has been raising interest rates since June 2004.
Pundits debate about whether the ECB or the Fed will be the first to reverse course and follow the other’s path. But for the moment, there’s more than one way to interpret the economic winds blowing.
At the heart of which view carries more intellectual weight lies the subject of rising energy prices, and the associated question of whether one should dismiss or accept the threat. Depending on your response, inflation in the United States looks either threatening or contained. For example, inflation (measured by the consumer price index) advanced by 3.6% for the year through August, according to the Labor Department. Stripping out food and energy—resulting in the so-called core rate of inflation—leaves a much lower pace of inflation, rising by just 2.1% over the same span.
The gulf between the two rates can be mostly explained by energy. Indeed, the energy component of the CPI soared by more than 20% for the year through August, by far the biggest rise of any component impacting the government’s calculation of consumer prices.
Considering the Fed’s recent bias for monetary tightening, Greenspan and company appear inclined to see the top-line inflation rate as the primary danger. In fact, Philadelphia Fed President Anthony Santomero said as much on Tuesday, when he explained, by way of Reuters via The Washington Post: “To keep cyclical price pressures and any transitory spike in energy prices from permanently disrupting the price environment, the Fed will have to continue shifting monetary policy from its current somewhat accommodative stance to a more neutral one.”
If that was too subtle, Dallas Fed Bank President Richard Fisher sharpened any smooth edges today by asserting that the central bank must stop an “inflation virus” from attacking the U.S. economy, according to Bloomberg News. Inflation, he said, exhibits “little inclination” to slow and in fact is approachign the “upper end of the Fed’s tolerance zone.”
Interest rates, it seems, will continue rising for the foreseeable future in these United States. That is, until they stop rising. In the meantime, Mr. Market will be looking for any signs that the Fed’s preference for fighting inflation rather than recession as the primary goal for monetary policy. For the moment, however, he’s just asking the question and not getting a lot of definitive answers. Case in point: today’s mixed results from a September report on sales results from retailers as a reason to continue wondering what comes next. No wonder the 10-year Treasury’s yield, at 4.37% at the end of today’s session, was virtually unchanged from yesterday.
Don’t just do something, stand there!