- - Sunday, February 16, 2014


The most important president in America may not be Barack Obama, who chases golfing dreams in drought-stricken California while we pause this holiday to honor giants like Washington, Jefferson, Lincoln, Roosevelt and Reagan.

The person whose spirit, spine and actions could affect each of us most is William C. Dudley, president of the Federal Reserve Bank of New York. If it becomes clear to Mr. Dudley that inflation is building across America, he and his colleagues at our central bank will have to increase interest rates, perhaps abruptly.

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Why inflation matters in 2014

This week, we get report cards on inflation — the degree to which prices are rising for goods and services.

Held in check for years, inflation is not an abstract term for most Americans. Minuscule increases in the cost of food, health care, mortgage interest, gasoline, clothing and electricity have profound negative consequences.

In 2012 (the most recent year for which government estimates are available), the bottom 80 percent of U.S. households earned $39,636 after taxes and spent $39,443.

Because these Americans have a razor-thin cushion of savings and are constrained in covering shortfalls by borrowing, inflation makes for painful choices and high anxiety.

Failing to tame inflation poses dangers not only for Americans, because the U.S. dollar is the world’s reserve currency, used around the globe to store the vast amount of wealth.

If foreign investors believe we will not take steps to defend the value of our currency by lifting benchmark interest rates, the ensuing financial crisis will prove far more threatening than what happened beginning in September 2008.

A new world of rising interest rates

Since 2007, interest rates that professional investors in U.S. securities watch closely have fallen below recent historical average levels.

From 2008 through 2012, the average annual interest rate on 10-year U.S. government debt was 2.94 percent, compared to 4.71 percent from 2000 through 2007.

A second key interest rate is the one that large banks pay to attract overnight deposits — the “effective federal funds rate.”

Even experienced investors do not fully appreciate how much the effective federal funds rate has been suppressed since 2007 and the impact that raising this benchmark rate will have on our economy.

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