Just before Hurricane Katrina struck a glancing category 1 blow at south Florida and then roared through the Gulf of Mexico to devastate Louisiana and Mississippi as a monstrous category 4 Hurricane, oil prices touched $70 a barrel and the Fed continued to nudge rates higher.
In the context of the terrible physical destruction and human tragedy along the Gulf coast, talking about economics pales in importance. But oil prices, interest rates, and economic activity in general will have a real impact on the recovery of the people most affected in this natural disaster, and that makes what Kathleen Camilli, president of Camilli Economics in New York, had to say just before this event even more poignant.
In your Camilli Economic Insights report you wrote about how consumers are being affected by oil at $67 a barrel and higher, and that you felt that the Fed Funds rate of 3.5% is high enough for now. Why? I’m mostly worried that higher oil prices will eventually start to crimp economic activity. I’m much less concerned than the Fed about the potential inflationary impact and more concerned about the negative economic impact at this level of oil prices. What caused me to write that article is that Wal-Mart has sounded this siren that at this level of oil prices their lower-income consumers are starting to be affected. The threshold may not have been at $40 or $50, but certainly at close to $70, it now is a concern.
And $70 has been a number that people have quoted for quite a while, right? I think there’s tremendous uncertainty within the economics community about what level is important. There was apparently a report that came out of Goldman Sachs that said nothing will happen until [oil] goes to $80 to $100 and then it will stay there for five years, so I don’t think there’s been much agreement at all about what level would have a dampening impact. Some people with a standard econometric model thought that a much lower level of oil prices would have an impact and the reason I say that [there is uncertainty] is not only because of them, but the consensus forecast in the economics community in the beginning of this year was that growth would slow to 3.6% because of oil, and that has been wrong.
Do you feel that if rates continue to go higher, even to a 6% Fed Funds level, that’s where we might get a squeeze? I don’t think Fed Funds should go much beyond the current level, 3.5%. I participate in the Blue Chip Forecasts, which are done monthly, and I just reluctantly, begrudgingly, forecast another quarter-point increase, to 3.75%. But I really think the Fed should pause here because of the uncertainty regarding the potential negative implications for the economy that are already in the pipeline.
Can you detail those? Some lower-income consumers are already being affected by higher oil prices and it’s causing a substitution effect in their family budget where–because they need to consume energy, whether it’s for transportation or for heating or for air conditioning–they need to substitute out something else in order to pay for that higher cost of energy.