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Tue Nov 1, 2005 1:32 PM ET
NEW YORK (Reuters) - Rising inflation in the United States remains a concern
and the newly-nominated head of the Federal Reserve will have his hands full
dealing with it, former Fed Chairman Paul Volcker said on Tuesday.
"We'd better be careful about inflation. Once we start relaxing on the
inflation front, then that would be a problem," Volcker said, addressing a
forum co-hosted by the Maxwell School of Syracuse University and U.S.
research firm Public Agenda.
Volcker, who was Fed chairman from 1979-87, said with higher inflation, Fed
chairman-nominee Ben Bernanke is faced with huge challenges ahead.
"He's a good economist and he's certainly well-trained there at Princeton,
but he has a lot of challenges ahead of him with high U.S. debt and
inflation," the former Fed chief said of Bernanke's nomination.
The U.S. Commerce Department on Monday released data showing that the PCE
price index -- an inflation gauge closely watched by the Federal Reserve --
surged 0.9 percent in September, its largest increase since February 1981.
The core PCE price index grew a milder 0.2 percent during the month, but it
was nonetheless higher than market expectations for a 0.1 percent rise.
The surge in inflation has been mostly attributed to the spike in U.S. oil
prices, as demand continued to outstrip the world's limited supply.
U.S. oil futures set a record of $70.85 per barrel in late August, before
falling to just under $60 on Tuesday, as warm weather eased demand for
heating oil in the U.S. Northeast.
In response to growing price pressures, the Fed has raised interest rates 11
times since last year and is expected later on Tuesday to announce another
quarter-percentage point increase in the benchmark federal funds rate to 4.0
percent.
Volcker is widely credited with ending the U.S. inflation crisis of the
early 1980s by contracting growth in money supply through a sharp increase
in interest rates. Inflation at around 14 percent in 1980 was lowered to
roughly 3 percent by 1983, analysts say.
The move, however, resulted in a steep drop in U.S. gross domestic product
growth and an increase in unemployment. However, both GDP and unemployment
returned to normal levels when inflation was solved and interest rates were
lowered.
Volcker also expressed concern about the sustainability of the U.S.
economy's expansion, citing the country's current account deficit -- a broad
measure of the nation's global trade and investments.
The current account gap is currently running at about 5-6 percent of U.S.
GDP.
In order to fund that deficit, dollars must flow into the country in the
form of portfolio inflows. If inflows are not large enough to offset the
dollars going offshore to buy foreign goods, then the dollar will decline.
"The U.S. economy is doing very well, the question is how long it would
last. Consumption is in general terms being financed by a lot of borrowings
abroad," he said.
Volcker said the United States is consuming and investing about 6 percent
more than the country is producing.
The United States is absorbing about 80 percent of the net flow of
international capital, he said, and at some point central banks in countries
like Japan and China will have their surfeit of dollars.
"I think in the long run that's (consumption and investment) unsustainable,"
he said.
Asian central banks, which have been buying dollars in order to curb their
currencies' appreciation against the U.S. dollar, are among the biggest
holders of dollar-denominated U.S. Treasury bonds.
Volcker most recently chaired the U.N.-established Independent Inquiry
Committee, which found after a year-long investigation that an estimated
2,200 companies -- including DaimlerChrysler, Siemens and Volvo -- made
illicit payments totaling $1.8 billion to Saddam Hussein's government under
the U.N. oil-for food program.
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