Avoiding Misery

The "misery index" was introduced during the stagflation era of the 1970s to account for a combination of inflation and unemployment -- two things that are not supposed to go together ordinarilly. During that period, the Fed responded to high oil prices by jacking up interest rates (for fear that high oil prices would spur inflation), and produced an economic slowdown. This time, hopes Irwin Stelzer, the Fed will respond more gingerly as it searches for an interest rate that won't bring the economy to a halt.

Stelzer points out that there are good reasons for the Fed ceasing its tightening campain. Longer term interest rates are finally rising in response to the Fed's 16 hikes. Also, the housing market is showing some signs of cooling. Orders for durable goods fell at a surprising clip in April. Moreover financial markets are as jittery as they've been over the past three years, with no clear winner for the moment between bulls and bears on Wall St. Additionally, the oil and natural gas supplies appear threatened by government takeovers of oil fields in Latin America and Vladimir Putin's threats to cut off gas supplies.

On the other hand, new home sales were up strongly in April, personal incomes are rising along with corporate earnings, and the weaker dollar is making imports more expensive. These factors argue for the Fed to continue tightening.

Stelzer concludes (or perhaps hopes) that the Fed has learned its lesson from the '70s, and that if it continues to tighten, it will do so gradually.