Your Dollar This Year



blitt chandan 14 Your Dollar This Year

SEE ALSO: What Time Is It? (We Mean Now)

My standard holiday routine requires that I travel home to Canada each December. Upon my arrival in Montreal, my welcoming family has come to expect that shopping for gifts will rise to the top of my agenda. Buying presents north of the border has historically offered two benefits: Apart from an easier trip through the customs declaration process, a favorable exchange rate has made it relatively cheaper to shop Canadian.

The decline of the greenback over the past decade has chipped away at my customary holiday arbitrage. From its nadir-which happened to coincide with the Bank of Dad spending devalued Canadian dollars to purchase my American dollar education-to the present, the loonie has made impressive gains against its southerly counterpart. Supported by an oil- and resource-rich foundation, the Canadian dollar is a petro currency, appreciating when oil and other commodity prices rise. Sound management of the federal budget, a healthier banking system and prevailing interest rates are also supporting the loonie.

In time for my next holiday shopping trip, the loonie could cede some of its gains if global oil prices should slide or if interest rates in the United States should rise, diverging from the prevailing rates in Canada. Forecasting of oil prices is a thankless exercise. As concerns short-term interest rates, the baseline holds that rates will remain near zero until the economy has weaned itself off the government’s largesse and a durable recovery is under way. Consistent with this expectation, the Federal Reserve has stated that monetary policy will remain unusually accommodative for the foreseeable future.

The current interest rate position was reiterated at the mid-December Federal Open Market Committee meeting: “The Committee will maintain the target range for the federal funds rate at 0 to 0.25 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.” Policy makers have the flexibility to pursue policies in extremis because of the prevailing price stability.

But if the recovery is stronger than anticipated, or if credit eases apart from an economic recovery, inflationary pressures could rise substantially. The interest rate response should anticipate price instability rather than react to it. This Sunday, at the American Economics Association meetings in Atlanta (from where I am writing), Fed Vice Chairman Kohn made the case as follows: “Because monetary policy typically acts with long lags on the economy and price level, the choice of when and how to exit will depend on forecasts. We will need to begin withdrawing extraordinary monetary stimulus well before the economy returns to high levels of resource utilization.”

Also on Sunday, Chairman Ben Bernanke offered a similar view: “Because monetary policy works with a lag, effective monetary policy must take into account the forecast values of the goal variables, rather than the current values. Indeed, in that spirit, the FOMC issues regular economic projections, and these projections have been shown to have an important influence on policy decisions.”

 

Will Inflation Projections Rise in 2010?

For the time being, projections for inflation remain subdued. The Fed’s central tendency projection for personal consumption expenditure inflation falls below 2 percent through 2012. Core inflation falls slightly lower, on account of the exclusion of energy cost pressures, and well within the implicit target range. Of course, these are dynamic forecasts, since the Fed seeks to anchor expectations about inflation as a means of guiding the actual inflation rate.

Free of incentives to steer the outcome, the International Monetary Fund similarly projects that consumer price inflation will reach only 1.7 percent in 2010. But consumers are less optimistic. As reported in the Dec. 23 Reuters/University of Michigan Survey of Consumers, one-year inflation is pegged at 2.5 percent. The long-term inflation expectation is 2.7 percent.