And now, inflation?

Network News

X Profile
View More Activity
Friday, February 25, 2011

AS YOU HAVE no doubt noticed, the average price of regular gasoline in the United States is $3.19 a gallon - up more than half a dollar since a year ago. The cause is the skyrocketing price of oil, which in turn reflects not only increased global demand but also turmoil in the Middle East. The prices of other commodities - coffee, cotton, corn - are also rising and may soon be passed along to you. Could inflation, which is already running at 5 percent in China, 4 percent in Britain and 2.5 percent in the euro zone, be about to compound the woes of an American economy still reeling from 9 percent unemployment?

The Federal Reserve, plausibly, says not to worry. Until recently, in fact, the Fed has been concerned that prices were rising far too slowly, threatening a deflationary spiral like the one that crippled the United States during the Great Depression. Preventing deflation is one reason the Fed launched a $600 billion bond-buying program, due to expire in June - and has kept interest rates at near-zero levels. Fed experts say the plan is working, as shown by the fact that forecasters are predicting up to 4 percent economic growth this year, while "core" inflation - price increases of consumer goods except for volatile food and energy - remains at a tame rate of 1 percent. There is still too much slack in the U.S. economy - unused factory capacity, idle workers - to trigger an inflationary spiral, the Fed argues.

Still, the latest figures are no cause for complacency. The U.S. producer price index, which measures factory- and farm-gate prices for newly made goods and services, ticked up nearly 1 percent in each of the past two months. Core inflation does indeed remain well within the Fed's safety range, but it has nevertheless begun trending upward, and one leading forecaster, Deutsche Bank Economic Research, says it could hit 2.1 percent, the upper limit of the Fed's usual target range, by the end of 2011. That could force the Fed to raise interest rates, slowing growth before unemployment has returned to pre-recession levels, in order to preserve its inflation-fighting credibility.

By vastly expanding its balance sheet and running an easy money policy, the Fed helped a crashing economy make a soft landing. The risk, as the central bank and its chairman, Ben S. Bernanke, know perfectly well, is that the Fed will miss the moment for a noninflationary withdrawal of this monetary stimulus, or botch the "exit strategy" when it comes. In that nightmare scenario, the oceans of Fed-created liquidity would fuel an inflationary spiral amid still-high unemployment - a replay of the 1970s' disastrous stagflation. It could all happen much more quickly and unexpectedly than economic models predict. Inflation is not a here-and-now threat, but it's not too soon for the Fed to begin planning for an inevitable adjustment.


© 2011 The Washington Post Company

Network News

X My Profile