Bernanke noted in congressional testimony that commodity price increases "by itself are not sufficient to evaluate the inflation situation". Commodity prices do not provide"pure information about inflation".
All of what Bernanke says is very true. However, the increases in commodity are not really supply shocks but caused by excess demand from the increase in wealth in many emerging market countries. The increase in consumer demand is a result of relatively loose monetary policy over the last few years. Commodity price shocks are not thought of as inflationary, but the impact of price shocks with commodities are often the same as an inflation increase if the commodity effect large portions of the economy or consumer. There is an erosion of purchasing power and a decrease in nominal wealth.
The true issue of inflation is interjected when we look at the potential reaction of the central bank. If the central bank wants to offset the erosion of wealth from the price shock in commodities, then it will decrease interest rates which will increase the amount of money in the system, This increase in money supply will potentially lead to a general increase in prices which is inflationary. Does the Fed monetize these price shocks? The Fed will say that they do not. They will state that they are providing liquidity to offset the downturn caused by the credit and housing markets, yet the same problem exists in the case of a commodity price shock. Does the Fed use monetary policy which affects the entire economy, to solve a localized or specific shock whether housing, credit, or commodities. It is the blunt instrument of monetary policy which has the potential for inflation.
All of what Bernanke says is very true. However, the increases in commodity are not really supply shocks but caused by excess demand from the increase in wealth in many emerging market countries. The increase in consumer demand is a result of relatively loose monetary policy over the last few years. Commodity price shocks are not thought of as inflationary, but the impact of price shocks with commodities are often the same as an inflation increase if the commodity effect large portions of the economy or consumer. There is an erosion of purchasing power and a decrease in nominal wealth.
The true issue of inflation is interjected when we look at the potential reaction of the central bank. If the central bank wants to offset the erosion of wealth from the price shock in commodities, then it will decrease interest rates which will increase the amount of money in the system, This increase in money supply will potentially lead to a general increase in prices which is inflationary. Does the Fed monetize these price shocks? The Fed will say that they do not. They will state that they are providing liquidity to offset the downturn caused by the credit and housing markets, yet the same problem exists in the case of a commodity price shock. Does the Fed use monetary policy which affects the entire economy, to solve a localized or specific shock whether housing, credit, or commodities. It is the blunt instrument of monetary policy which has the potential for inflation.
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