Stop the Credit Crunch, and Let the Economy Grow

Worries about inflation are misplaced in today's global economy.

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The Wall Street Journal and a good number of folks on Wall Street are coming to the realization that we're not in a recession, despite three years of housing turmoil and high gas prices and five months of credit market chaos. "Fourth Quarter GDP Back in the Black," is how the Journal puts it today as it notes Macroeconomic Advisers, Lehman Brothers, JP Morgan, and Morgan Stanley have all increased their forecasts for the current period by a percentage point or so. Yesterday's great retail sales news is a big reason for the renewed optimism. Now those firms are talking about growth in the roughly 1 to 1.5 percent range, hardly a boom to be sure. Yet the numbers do show the underlying strength in the American economy. We just need to get by this credit crisis. George Magnus, a senior economic adviser to UBS Investment Bank, put it well in yesterday's Financial Times:

What the financial system cannot deal with properly is a drying up of funding liquidity, reflected in exceptionally high interbank rates.... The longer this continues, the greater are the systemic and economic risks. Inflation risk is perhaps the main economic concern for central banks and investors. But whatever the inflation risks in the next few years, it seems unreal to worry about backward-looking food and energy price rises when a nasty deflationary credit crisis is just starting. No banking crisis has ever been followed by rising inflation (except the mid-1970s when oil prices quintupled). Core inflation in most countries remains tame and there has been little pass-through of prices from headline to core rates. Thanks mainly to globalisation, wage rises and pricing power remain subdued. As output growth slows in developed countries, commodity prices are likely to drop. ... As monetary policy must be forward-looking, it is appropriate to ease monetary conditions pre-emptively. This will not stop house prices and collateral values from falling. It can help, at the margin, to rebuild confidence and liquidity in the functioning of financial markets.