Economic cross-currents are confusing retail investors and central bank policy makers alike. We lurch from recovery to double-dip as new evidence emerges, while policy makers grapple with fears of inflation in the presence of evidence of deflationary weakness.
Confusing matters all the more, the US and Europe are heading in different intellectual directions.
In the UK and Europe, the highest bankers of the land are setting the stage for both monetary and fiscal tightening.
Bank of England’s Mervyn King warns over inflation
Prices rises have consistently defied the Bank’s expectations of a slowdown, adding to pressure on households as wage growth remains weak and the Government introduces a strict austerity package.
The Bank’s rate-setters are charged with keeping inflation at 2% but the Consumer Prices Index benchmark has been above 3% throughout the year.
However, addressing a committee of MPs, Mr King suggested that they will be reluctant to try to curb the problem by raising borrowing costs from 0.5 per cent any time soon because of the weakness of the economy.
The word Mr. King is seeking here is “stagflation,” the definition of which includes inflation with very low or no economic growth. That seems to describe the UK well at this point. It’s a devilish combination to fight, because central bank tools are extremely blunt and tend to work only in one direction, not both at once. Raising rates to drive down inflation will also put pressure on households facing rising costs and stagnant wages, effectively killing both inflation and households at the same time. That’s not much help.
So what’s a banker to do?
Mr. Trichet, head of the ECB, recently penned this Financial Times OpEd, in which he essentially wags his finger at the political class, informing (warning?) them that central bankers expect various European governments to get their fiscal houses in order.
Stimulate no more – it is now time for all to tighten
The acute fiscal challenges across all industrial economies are no surprise.
by rhare 
