The risk of asset prices

The risk is that higher headline inflation is misinterpreted as a sign that policy is too loose. Judged by the “breakeven” rate between inflation-protected and other Treasury bonds, financial markets’ estimates of long-term inflation have jumped of late, although consumers’ expectations have remained stable (see chart). Worries about the size of America’s budget deficit and fears about the potential politicisation of the Federal Reserve are rising. (A proposal released this week by the Senate Banking Committee which strips the Fed of supervisory powers and introduces political appointments to the regional reserve-bank boards hardly helps). There is a danger that higher headline inflation will be misread, even as rising energy costs sap demand.

Vince Reinhart of the American Enterprise Institute worries about a replay of the summers of 2007 and 2008. On both occasions a weaker dollar, rising oil prices and a “decoupled” world economy made America’s central bank more hawkish. Although it did not raise rates, “inflation jitters” were pervasive. The European Central Bank actually raised rates in July 2008.

History will not repeat itself exactly. But bubbly asset prices do risk overreaction from rich-world central bankers. That may temper worries in the emerging world but at the risk of pushing the global economy back into recession. Central bankers ignore asset prices at their peril. But dealing with them is not easy either.