Friday, February 17, 2012

Inflation: Still Not A Threat

The Lehmann Letter (SM)

Critics of the Federal Reserve have expressed concern that the Fed's expansionary policy will generate rising inflation. But it hasn't, and this morning's report from the Bureau of Labor Statistics should cause no concern:

The BLS reported that consumer prices grew at a 2.4% seasonally adjusted annual rate in January (multiply the 0.2% monthly figure by 12).

Take a look at the chart and you will see that prices have been rising on average by this amount for two decades. There is no current evidence for surging inflation.

Change in Consumer Prices
(Click on chart to enlarge)

(Recessions shaded)

Why not? Shouldn't the Fed 's expansionary policy lead to excess demand that drives prices higher at an increasing rate?

It depends. If households and businesses were willing to exuberantly borrow and spend, and if producers were operating at full capacity, then an expansionary monetary policy would be inflationary. But those are two big "ifs."

Households and businesses are not borrowing and spending at exuberant rates despite the Fed's low-interest-rate policy. (Also keep in mind that lenders have raised their standards, thereby offsetting the low rates of interest.) And producers are operating well below full capacity (see the February 15 issue of this letter), enabling them to boost output at minimum increase in cost.

Take another look at the chart. Inflation surged in the 1970s because of robust borrowing and spending and high capacity utilization. But those particular circumstances do not apply today.

Today's circumstances are much closer to the "pushing on a leash" scenario. The Fed's monetary policy is much better at restraining demand then stimulating demand. The Fed can hold the economy back by raising interest rates, but it is difficult under today's circumstances to push it forward by lowering interest rates. That's why the Fed's monetary easing has failed to generate rising inflation to date.

(To be fully informed visit

© 2012 Michael B. Lehmann

No comments: