Today's article in the Wall Street Journal reporting on the speech of Federal Reserve Chairman Ben Bernanke at the Jackson Hole conference (http://online.wsj.com/article/SB121941429990263697.html?mod=hps_us_whats_news) contains this paragraph:
"Some Fed officials have called for raising rates before long to address worries about inflation. Consumer prices rose 5.6% in July from a hear earlier, a 17-year high. However, most officials believe a weak economy will lessen the inflation threat, and they want to keep rates lower for now to offset tightening credit conditions."
This speaks precisely to the point I made in my post of August 22, 2008, "It's the Supply Side, St....". If you believe that the problem being faced by the policy makers is one of insufficient aggregate demand, then there certainly should be pressure for inflation to weaken.
However, if you believe that the weakness in economic growth comes because of a shift in aggregate supply then there WILL NOT be pressure on the general rate of inflation to decline.
Of course, both aggregate demand and aggregate supply shift. Thus, it is a question of which one of the two dominates. If shifts in aggregate demand dominate then the economy will weaken and inflation will lessen. However, if the shifts in aggregate supply dominate then the economy will weaken but inflation will not lessen.
How the current situation is interpreted is IMPORTANT both for the policymakers in Washington, D. C., but also for business leaders and investors!