Predictions

How will the spike in oil and food prices affect the global economy? Mohamed El-Erian of Pimco, writing in the FT, makes a number of predictions I'm inclined to agree with.

As to the first-round effects, El-Erian predicts:

The price shock will serve to undermine real incomes in the US and lower imports. On the policy front, it will accentuate the tug of war that the Federal Reserve faces on account of its now conflicting inflation and employment objectives. Emerging economies face greater inflation in the context of their buoyant liquidity conditions. Several will see their real effective exchange rates appreciate, by means including measures to allow the nominal exchange rate to appreciate markedly against the dollar. In Europe, growing demands for wage increases may force companies to step up structural reforms and will cause the European Central Bank to increase its hawkish rhetoric.

And the second-round effects:

In the US, look for renewed pressure for further fiscal stimulus and a monetary policy that, while appropriate for the US, is too inflationary for the rest of the world. In Asia and the Middle East, the spike in inflationary pressures may inadvertently slow the move towards more efficient tools of indirect economic management. In Europe, expect attempts to bypass fiscal responsibility guidelines in order to mute political protest.

I'm about two-thirds of the way through El-Erian's new book, When Markets Collide, and it's fantastic so far. It gives a great big-picture view of the global economy, and makes persuasive case for reforming the international institutional set-up.