Over-stretching the case for inflation

I continue to think it makes more sense to fear inflation than deflation, but I cringe when I read “inflationists” who continue to over-state the case for inflation. Two recent pieces that appeared in Project Syndicate are case in point: “When Inflation Doves Cry” by Allan Meltzer and “The Ghost of Inflation Future” by Brigitte Granville.

Allan Meltzer wrote “A History of the Federal Reserve” and is considered an expert on the Federal Reserve. He wrote recently to complain about a cover story in the Wall Street Journal that declared victory for the inflation doves over the hawks. Meltzer essentially called the doves lucky. He insisted that the lack of inflation despite the Federal Reserve’s massive growth in its balance sheet was something no one on either side of the divide predicted. I actually seem to recall plenty of deflationists from 2008 to this very day who have scoffed at the notion that the Fed can do anything to stop an eventual deflationary collapse. So, I think Meltzer is too broad in trying to excuse himself for being wrong all these years about the immediate inflationary consequence of quantitative easing (for Meltzer’s dire warnings on inflation early in the crisis see his 2009 interview on EconTalk).

Even more problematic for me is that Meltzer calls on the Federal Reserve to stop paying interest on reserves, the very thing that is containing the kind of increase in the monetary supply that will surely boost inflationary pressures. Meltzer also seems to imply that the Fed should simultaneously raise interest rates and work down the reserves on the balance sheet. These two prescriptions strike me as deflationary. I suppose there is some formula whereby all these can be done in a harmony that can spur non-inflationary growth and avoid deflation, but Meltzer does not make it specific. (It is also possible that the strict limits on article length in Project Syndicate made it impossible for him to clarify).

In 2010, Mletzer wrote in the Wall Street Journal that eventually banks would start loaning out the money currently held in reserves. The only reason to do this would be if banks felt they could make more money than simply accepting the free money from the Fed. Meltzer did not say what would motivate such lending except to suggest that the Fed would get the rate on reserves wrong. Now, three years later, to advise that the Fed drop the rate altogether is to ask for a free pass to make a prophecy come true.

Mind you, I am sympathetic to the case that says the Fed will not be able to contain inflation when it finally starts up again, but the specific mechanism for a reignition of inflation is still not quite clear yet in my opinion. The Fed seems inclined to maintain an accomodative stance well into an economic recovery in order to ensure that the recovery has firm roots. That bias is certainly the seed from which inflationary pressures can (will) grow…but we need that recovery first!

Brigitte Granville wrote “Remembering Inflation” which makes the case for establishing inflation targets as a tool for maintaining the inflation-fighting credibility that central banks need to foster stable prices (see summary at Princeton University Prcess). In her piece on Project Syndicate she concludes by warning that Europe will soon go from depression to high inflation. It is a bewildering prediction given she acknowledges that the European Central Bank cannot raise its inflation target, and its program of “outright monetary transactions” must be accompanied with tight fiscal policies. In many ways, the ECB is acting as if it fears inflation more than deflation. Moreover, Granville notes that as a consequence heavily indebted nations in the eurozone will eventually be forced to restructure their debt with creditors (instead of attempting to inflate away the debt with a devalued currency). Without a devlation in the currency, I have a hard time understanding how such restructuring will trigger inflation. Instead, it is likely to make it even more difficult for borrowers in these countries to access the credit markets, sterilizing an important inflation-generating mechanism.

We inflationists have been premature and even wrong on our inflation expectations. Here on Inflation Watch, I finally acknowledged back in June that it was time to cool my inflation expectations. I still promise to maintain vigil and write related pieces, but it just does not make sense to write in such expectant tones…at least not until something fundamentally changes in the inflation picture. In the meantime, inflationists would do well to avoid predictions of inflation until they (we) can specifically describe exactly how (and when?) the inflationary threat will manifest itself. The odds for an imminent inflationary spiral are NOT 100%, probably not even 80%…


Asian inflation may finally be cooling

Thanks to improvements in crop production, monetary tightening, a slowdown in economic growth rates, and currency appreciation, the trend now appears to be heading down for core and headline inflation in Asia. Different countries are wrestling with different problems, but, overall, economists and analysts quoted in “Food Inflation Begins to Moderate in Asia” seem to be getting optimistic about the prospects for inflation.

The article includes some statistics on the huge difference in price trends on various food items in India:

“The cost of bananas in New Delhi is up 50 percent over the year, while paneer – a form of cottage cheese – has risen 26 percent to 145 rupees per kg.

Yet other food prices are falling. Staples such as tomatoes and potatoes, which peaked earlier in the year at levels that caused great stress to poorer families, have seen prices moderate in recent weeks.”


The Federal Reserve May Choose to Ignore the Inflation Expectations of Households

(Originally appeared in “One-Twenty Two“)

First, Bernanke made it clear he thinks gold is not a good indicator of inflation expectations. Now, the Federal Reserve Bank of San Francisco has produced research that could convince the Fed to insulate itself from the inflation expectations of average Americans in “Household Inflation Expectations and the Price of Oil: It’s Déjà Vu All Over Again” by Bharat Trehan (thanks to Bill Fleckenstein for calling this article to my attention).

Household inflation expectations have risen to 4.5% from 3% at the end of 2010. Fortunately for the Federal Reserve, its empirical research seems to show that household expectations have become inaccurate and irrelevant for monetary policy:

“This Economic Letter argues that the jump in household inflation expectations is a reaction to the recent energy and food price shocks, following a pattern observed after the oil and commodity price shocks in 2008. The data reveal that households are unusually sensitive to changes in these prices and tend to respond by revising their inflation expectations by more than historical relationships warrant. Since commodity price shocks have occurred relatively often in recent years, this excessive sensitivity has meant that household inflation expectations have performed quite badly as forecasts of future inflation.”

Trehan admits that the University of Michigan’s Survey Research Center shows that households had been pretty good indicators of future inflation from the 1970s to 2000. However, over the past several years, the increased volatility in the prices of food and energy have misled consumers to anticipate more future inflation than is warranted given low levels of existing core inflation:

“The recent jump in the Thomson Reuters/University of Michigan measure of household inflation expectations appears to be related to increases in the prices of energy and food, similar to the jump observed in 2008. The size of this response to noncore inflation cannot be justified in terms of the historical relationships in the data. This disproportionate response is probably the reason why household inflation expectations have not done well as forecasts of future inflation in recent years, a period of volatile food and energy inflation. The poor forecasting performance argues against reacting strongly to the recent increases in household inflation expectations.”

Moreover, recent increases in inflation expectations are not justified by changes in monetary policy. Trehan speculates that…

“It’s also possible that households’ sensitivity to noncore inflation goes up following substantial, sharp increases in the price of energy and food items, such as those that occurred in the 1970s and over the past few years…This similarity to the 1970s is unsettling because it suggests that consumers are not accounting for the ways monetary policy has changed over this period.”

I assume this claim means that the Federal Reserve’s monetary policies have improved since the 1970s. In my opinion, we have seen even less reason to trust in the Federal Reserve’s policies to the extent that these policies “fix” economic problems in such a way to help set up the next crisis. These crises build while the Federal Reserve tends to reassure that it has everything under control and/or there is nothing happening to cause concern.

I would challenge the historical record and related regressions to suggest we need to consider whether the structural underpinnings of inflation are changing in ways that the Federal Reserve will be slow to recognize. Whether the Federal Reserve can do anything about these changes is another question.


A danger of inflation: The misallocation of resources on the way to sustained price increases (an explanation of the mission of Inflation Watch)

In January of this year, Professor Russ Roberts of George Mason University invited fellow economics professor Don Boudreaux to address “Monetary Misunderstandings” on the weekly podcast “EconTalk.” From the synopsis:

“Don Boudreaux of George Mason University talks with EconTalk host Russ Roberts on some of the common misunderstandings people have about prices, money, inflation and deflation. They discuss what is harmful about inflation and deflation, the importance of expectations and the implications for interest rates and financial institutions.”

I was most interested in the discussion about the definition of inflation because I understand the importance of maintaining technical and economic clarity on this topic for “Inflation Watch.”

Boudreaux first deferred to Milton Friedman’s famous empirical proclamation “inflation is always and everywhere a monetary phenomenon” and lamented that the economics profession no longer defines inflation as an increase in the money supply. Now, inflation represents a sustained increase in the average price level in the economy. Inflation is not simply any increase in price; Boudreaux complained that this definition is a common misconception of non-economists. However, he acknowledged that he personally thinks inflation’s largest threat is the process by which price increases become sustained. This process features uneven injections of money into the economy, causing specific and identifiable distortions in the economy that lead to a misallocation of resources. (Roberts somewhat disagreed as he expressed much greater fear of hyperinflation).

Bill Fleckenstein first taught me this notion that increases in the money supply distort specific areas of the economy. Such distortions can morph into bubbles, inflation’s ultimate misallocation of resource (capital). Bubbles can occur without ever tipping the economy into an inflationary cycle via official government statistics. So, it is very easy, for example, for the Federal Reserve to do nothing about soaring prices in an important sector of the economy and instead simply plan for the ultimate clean-up of the bubble’s aftermath. In recent history, the disastrous wakes of bubbles have forced the Federal Reserve to resort to easy money policies that invariably help fuel the next bubble. (Fleckenstein famously reviews this process and a lot more in “Greenspan’s Bubbles: The Age of Ignorance at the Federal Reserve.”)

Through Inflation Watch, I identify news of price increases not because any one price hike defines inflation; as noted above, this approach is technically incorrect. Instead, these stories offer clues that potentially can uncover the misallocations of capital that flag inflationary forces may be developing. I am trying to piece together a mosaic of economic activity that may provide early indicators of inflation well ahead of the moment that government statistics show it or the moment the Federal Reserve officially announces an inflationary process is underway.

The general context is important. We are currently experiencing an extended period of easy money policies in most of the globe’s developed economies. Presumably, this money must go “somewhere” at some point in time. Financial markets are the perfect conduit for easy money; investors and speculators alike will flock to those parts of the economy that promise some protection against the devaluation of currency and/or profits from inflationary pressures. (Boudreax and Roberts never directly addressed the enabling influence of financial markets for transmitting inflationary pressures). I have argued in previous posts that the most favorable hosts for easy money are where demand is particularly robust and supply may be constrained or stressed. Today, commodities represent a perfect storm for global easy money policies. So, many of the recent stories in Inflation Watch have focused on commodities and industries dependent on consuming commodities.

The Federal Reserve’s current bias toward inflation shows because the Fed has demonstrated relatively quick action to thwart the perceived threat of deflation. The specter of the Great Depression always looms large. Recall that after the dot-com bubble burst, Greenspan cited the threat of deflation as a prime reason for aggressively loosening monetary policy. The crash of the housing bubble of course generated an even more aggressive policy of monetary easing given housing’s importance to the overall economy and consumer spending. The Federal Reserve’s recent success in averting deflation certainly adds confidence in applying easy money policies, much to the likely chagrin of devout deflationists. Meanwhile, the Federal Reserve has also made it clear that it will not act against inflation until price increases (or the expectation of price increases) reach sustained levels over time.

For example, last week, Bloomberg quoted Federal Reserve Bank of Chicago President Charles Evans in “Fed’s Evans Says ‘Slow Progress’ in Economy Justifies Maintaining Stimulus“:

“Inflation is a continuing increase in the price level over time: A one-off increase in the price level is not inflation…Price increases have to be sustained.”

I duly noted that at no time does someone from the Federal Reserve insist that deflation is a continuing decrease in the price level over time!

Evans goes on to express his comfort with the current levels of inflation by citing empirical research showing no correlation between higher oil prices and inflation. Even a casual examination of the current record of price increases demonstrates that oil’s price rise is just one small part of the general increase in prices percolating in the economy, especially where demand is strong and supply is compromised. Regardless, the conclusion of this research is intuitive given the numerous supply-related fluctuations in oil that have occurred with and without Fed monetary action. As we saw above, it is not likely that the increase in prices in any one part of the economy will produce the sustained increase in price levels required to signal inflation’s arrival. Without an increase in the money supply, increases in oil prices steal money from some other products in the consumer’s basket of goods. The net impact on official inflation statistics may be close to zero and “core” inflation, subtracting energy and food, could even decrease! But if increases in the money supply happen to coincide with a strengthening oil market, I contend we better look out.

The bias of the Federal Reserve toward inflation is also rooted in the concept that “a little inflation” is good for the economy because it encourages spending. Specifically, inflation encourages consumers to buy today to avoid paying higher costs tomorrow. In a deflationary environment, consumers just wait and wait and wait. Boudreaux and Roberts sharply criticize this theory and cite examples demonstrating the fallacy of such thinking. For example, with even a little inflation, why don’t sellers just wait until tomorrow to sell since they can make higher profits? Why do consumers buy computers and many other electronic goods knowing full well that prices will be lower tomorrow (not to mention these goods will be of higher quality)? Why was America’s post-Civil War economy so strong for almost 30 years despite persistent deflation? Clearly, buyers and sellers are motivated not just by relative prices, but also the relative value (or utility) gained from consumption and/or alternative investments.

I have covered the core concepts reviewed by Boudreaux and Roberts related to the philosophy and approach of “Inflation Watch.” If you want more detail, I highly recommend listening to the podcast, reviewing the transcript, and/or perusing some of the references provided by EconTalk. Hopefully, you have also gained a better understanding of Inflation Watch’s mission: “Watching for inflation here, there and everywhere.”


Fleckenstein declares deflation “dead”

I am two months late on this one.

In February, Bill Fleckenstein refuted the notion that inflation is a net positive in “No such thing as good inflation.” He starts by noting how higher prices in commodities are driving inflation expectations upward:

“As unprecedented amounts of liquidity from the Federal Reserve have worked their way through the financial system and into the real world, I believe inflation psychology has changed. People have seen larger price increases in commodities and are resigned to accept them, which will set the stage for additional rounds of price hikes.

Once that psychological shift becomes entrenched, it will be extremely hard to reverse, despite Fed Chairman Ben Bernanke’s stated certainty that he can keep prices under control…”

Fleckenstein goes on to insist that as long as the Federal Reserve is allowed to play free and loose with the dollar, deflation will not happen in America:

“I would like to officially declare the topic of deflation dead. As I have long maintained, we may actually experience deflation if the bond market rebels and takes the printing press away from the Fed. However, in the absence of that, it should be clear by now that deflation is not going to visit the shores of America.”

I made a related point back in October, 2008. Back then I thought we would see elevated inflation levels no later than 2010. Regardless, Fleckenstein provides to a great reminder that inflation is, and has always been, the threat once the Federal Reserve started throwing freshly printed bills at our economic calamities.


Deloitte survey suggests inflation expectations are not anchored


Small businesses getting bolder about price increases

In “Inflation Hits Main Street: Small Businesses Raising Prices,” CNBC reports that the National Federation of Independent Business found increasing interest in price hikes amongst its members:

“More than a quarter of small businesses are raising prices, or plan to soon, the highest amount in 28 months…”

The net number of small businesses already raising prices went positive for the first time in 2 1/2 years.


The Federal Reserve debates inflation

With so much heated debate and discussion about inflation in the media these days, I thought I would focus on how the Federal Reserve discussed and debated inflation in the latest meeting minutes released today.

The Federal Reserve’s staff economists concluded that while commodity prices have increased substantially and near-term inflationary expectations have also increased, the outlook for medium and long-term inflation remained stable. In other words, current inflationary pressures should prove “transitory.”

“Sizable increases in prices of crude oil and other commodities pushed up headline inflation, but measures of underlying inflation were subdued and longer-run inflation expectations remained stable…

…According to the Thomson Reuters/University of Michigan Surveys of Consumers, households’ near-term inflation expectations increased substantially in early March, likely because of the run-up in gasoline prices; longer-term inflation expectations moved up somewhat in the early March survey but were still within the range that prevailed over the preceding few years.

…Measures of inflation compensation over the next 5 years rose, on net, over the intermeeting period, with most of the increase concentrated at the front end of the curve, likely reflecting the jump in oil prices. In contrast, measures of forward inflation compensation 5 to 10 years ahead were little changed, suggesting that longer-term inflation expectations remained stable.

…The staff revised up its projection for consumer price inflation in the near term, largely because of the recent increases in the prices of energy and food. However, in light of the projected persistence of slack in labor and product markets and the anticipated stability in long-term inflation expectations, the increase in inflation was expected to be mostly transitory if oil and other commodity prices did not rise significantly further. As a result, the forecast for consumer price inflation over the medium run was little changed relative to that prepared for the January meeting.”

Some Federal Reserve members expressed their concern that current inflationary pressures may still lead to upward pressure on long-term expectations:

“…participants observed that rapidly rising commodity prices posed upside risks to the stability of longer-term inflation expectations, and thus to the outlook for inflation, even as they posed downside risks to the outlook for growth in consumer spending and business investment.”

InflationWatch has chronicled numerous instances of companies that either plan to or already have passed on price hikes to consumers. The Federal Reserve is also noticing, but their “contacts” are apparently not confident that plans for price hikes can stick:

“A number of business contacts indicated that they were passing on at least a portion of these higher costs to their customers or that they planned to try to do so later this year; however, contacts were uncertain about the extent to which they could raise prices, given current market conditions and the cautious attitudes toward spending still held by households and businesses.”

I often whether in these circumstances whether the Federal Reserve passes on some “friendly” advise to these contacts…

The most common reason cited for assuming inflation will remain tame is that there remains a large amount of slack in resource utilization in the economy. Someone on the Fed recalled an important exception to such assumptions:

“Some participants pointed to research indicating that measures of slack were useful in predicting inflation. Others argued that, historically, such measures were only modestly helpful in explaining large movements in inflation; one noted the 2003-04 episode in which core inflation rose rapidly over a few quarters even though there appeared to be substantial resource slack.”

One way to keep inflation expectations anchored is to insist that it will stay anchored. Ben Bernanke has planned to do press conferences, and the rulebook assurances over inflation may be part of the motivation:

“A few participants noted that the adoption by the Committee of an explicit numerical inflation objective could help keep longer-term inflation expectations well anchored.”

Finally, the topic of the Federal Reserve’s balance sheet came up. I have long maintained that the Fed will find itself unable to wind down this balance sheet quickly or in a timely fashion. Some on the Fed are afraid that more people like myself will harbor these same doubts:

“…a few participants noted that if the large size of the Federal Reserve’s balance sheet were to lead the public to doubt the Committee’s ability to withdraw monetary accommodation when appropriate, the result could be upward pressure on inflation expectations and so on actual inflation. To mitigate such risks, participants agreed that the Committee would continue its planning for the eventual exit from the current, exceptionally accommodative stance of monetary policy.”

This path toward an exit is likely fraught with monetary perils and should provide a lot more volatility in financial markets. Stay tuned.


Laurence Meyer confident in Fed’s ability to respond to an increase in inflation expectations

Laurence H. Meyer, a former governor of the Federal Reserve, wrote an op-ed in the New York Times titled “Inflated Worries” in which he confidently argues that inflation expectations remain well-contained and even if they became unhinged, the Federal Reserve is ready to respond quickly:

“The Fed, this argument goes, just won’t be able to act quickly enough to turn off the spigot when the time comes to do so.

But the Fed can raise interest rates directly any time it wants. In addition, it could start to sell the huge volume of Treasury securities and other financial assets on its books, which would also place upward pressure on rates.

Would the Fed act in time? I expect that it will. And even if it doesn’t act in time, and inflation expectations start to get out of line, I am confident that the Fed would tighten monetary policy quickly and aggressively enough to restore price stability and maintain its credibility on inflation. You can take that to the bank.”

Meyer’s unspoken assumption in this piece is that unemployment would not be so high that it discourages the Federal Reserve from acting. Ben Bernanke has made it abundantly clear that unemployment is front and center and that the growing concerns about inflation around the globe are not his or America’s concern. So, I remain extremely doubtful that the Federal Reserve is unconditionally prepared to act in the face of rising inflation expectations.

Meyer also explains in his piece the difference between core and non-core (or headline inflation). He disabuses the audience of the notion that higher food and energy prices increase inflation expectations citing Federal Reserve research that “…unequivocally tell us that core inflation better predicts overall inflation tomorrow” (see “Estimating the common trend rate of inflation for consumer prices and consumer prices excluding food and energy prices“). However, Meyer blithely ignores the study’s conclusion that this relationship did NOT hold during the 1970s and 1980s: “In the 1970s and early 1980s, movements in overall prices and prices excluding food and energy prices both contained information about the trend.” In other words, there is little in this study to suggest that the relationships are stable.

Ultimately, I think those who argue that there are fundamental, structural pressures that indicate increasing energy and food prices are reflective of inflation’s future direction, especially once supply constraints finally show up in more sectors of the economy, will prove to be the most prepared for the future. In other words, today’s food and energy inflation has been an early outcome of easy money policies because supply constraints and demand dynamics are most readily exploited in these sectors of the global economy right now. (I made a related argument when discussing the recent rapid increase in coffee prices).

Hopefully through inflation watch you have been able to note the growing pockets of inflation pressure and the increasing power companies have to raise prices at least at the producer level…


TIPS indicate annual inflation expectations above 3% for next 5-10 years

In “Look to TIPS, Not Fed, for Inflation Tips“, the WSJ describes how current trading in Treasury Inflation-Protected Securities (TIPS) indicates inflation expectations running above 3% per year for the next 3-5 years. The WSJ uses the Fed’s “5yr5yr breakeven” method.

Full disclosure: long iShares Barclays TIPS Bond Fund (TIP)


Could Federal Reserve’s disagreement over inflation forecast signal higher inflation in the future?

The minutes for the Federal Reserve’s December meeting indicates that November’s debate over inflation and inflation expectations continues.

For example, staff at the Federal Reserve continue to forecast a very tame pricing environment:

“The staff forecast for inflation was nearly unchanged. The staff interpreted the increases in prices of energy and nonmarket services that recently boosted consumer price inflation as largely transitory. Although the projected degree of slack in resource utilization over the next two years was a little lower than shown in the previous staff forecast, it was still quite substantial. Thus, the staff continued to project that core inflation would slow somewhat from its current pace over the next two years. Moreover, the staff expected that headline consumer price inflation would decline to about the same rate as core inflation in 2010 and 2011.”

But, on balance, the members of the Fed still disagree about the future risks of inflation:

“Some noted the risk that, over the next couple of years, inflation could edge further below the rates they judged most consistent with the Federal Reserve’s dual mandate for maximum employment and price stability; others saw inflation risks as tilted toward the upside in the medium term.”

The concerns of the “inflation hawks” are familiar:

“Participants noted that any tendency for dollar depreciation to put significant upward pressure on inflation would bear close watching.”

“Some participants noted, however, that rising prices of oil and other commodities, along with increases in import prices, could boost inflation pressures going forward.”

“A few participants noted that banks might seek, as the economy improves, to reduce their excess reserves quickly and substantially by purchasing securities or by easing credit standards and expanding their lending. A rapid shift, if not offset by Federal Reserve actions, could give excessive impetus to spending and potentially result in expected and actual inflation higher than would be consistent with price stability.”

In response to this debate, Reuters quoted an interesting perspective from St Louis Fed economist Kevin Kliesen:

“Kliesen suggested disagreement on the inflation outlook could provide some insight into what lies ahead, noting that past five-year forecasts of the average Consumer Price Index inflation rate from Blue Chip Economic Indicators show that when inflation was relatively high and variable, such as the late 1980s and early 1990s, there was sizable disagreement among forecasters about the medium-term inflation outlook.

By contrast, during periods when inflation tends to be relatively low and stable, such as the mid-1990s to mid-2000s, forecasters tend to disagree less about the… outlook.”

Perhaps disagreement leads to inaction, and the inaction becomes crippling when inflationary pressures finally surface. Even as the Federal Reserve takes initial steps preparing for the day it must drain liquidity from the economy, this “disagreement dynamic” deserves watching over the coming months.


Inflation Hawks on the Fed Express Concerns Over Inflation Expectations

The meeting minutes from the Federal Reserve’s Nov 3-4, 2009 meeting show that the inflation hawks (all one or two of them?) expressed concern over the longer-term outlook for inflation:

…some participants noted that the recent rise in the prices of oil and other commodities, as well as increases in import prices stemming from the decline in the foreign exchange value of the dollar, could boost inflation pressures….risks were tilted to the upside over a longer horizon, because of the possibility that inflation expectations could rise as a result of the public’s concerns about extraordinary monetary policy stimulus and large federal budget deficits. Moreover, these participants noted that banks might seek to reduce appreciably their excess reserves as the economy improves by purchasing securities or by easing credit standards and expanding their lending substantially. Such a development, if not offset by Federal Reserve actions, could give additional impetus to spending and, potentially, to actual and expected inflation.

However, colletively, the Fed assigns a very low probability to an eruption of expectations for high inflation:

Members noted the possibility that some negative side effects might result from the maintenance of very low short-term interest rates for an extended period, including the possibility that such a policy stance could lead to excessive risk-taking in financial markets or an unanchoring of inflation expectations. While members currently saw the likelihood of such effects as relatively low, they would remain alert to these risks.

The Federal Reserve believes that it stands ready to change monetary policy in response to higher inflation expectations:

“To keep inflation expectations anchored, all participants agreed that it was important for policy to be responsive to changes in the economic outlook and for the Federal Reserve to continue to clearly communicate its ability and intent to begin withdrawing monetary policy accommodation at the appropriate time and pace.”

Meanwhile, gold continues to hit all-time highs, record amounts of money continue pouring into commodities of all kinds, and TIPS hit fresh 52-week highs, far out-performing treasury bonds this year. It seems the Federal Reserve may have some catching-up to do…


Are We More Sensitive to Price Increases Than Decreases?

Erika Miller, correspondent at Nightly Business Report, expressed surprise that the CPI showed prices declined year-over-year by 0.2%:

“It came as a total surprise to me that grocery prices have fallen nearly 3 percent in the past year, one of the biggest category declines. I would have guessed prices at the supermarket were up.”

Ms. Miller speculates that we are more sensitive to price increases, than decreases. Thus, recent surges in the price of fuel and healthcare gain a lot more attention from consumers than small declines in grocery bills. (Of course, there is also the problem that declines in housing prices over the past year have compressed effective earning power at the same time that the costs of so many other things have increased – as chronicled here on Inflation Watch).

So, while the CPI reports a smoothed number that averages out the balance of pricing pressures in the economy, it could be that surges in the prices of certain items in a consumer’s basket of goods can influence expectations of future inflation much more than small decreases elsewhere. If this characterization is correct, it highlights the importance of having a comprehensive approach to battling inflationary pressure that looks at all the moving parts.

As an old quip points out – on average, you will feel fine if your head is in the oven and your feet are in a bucket of ice, but this setup is not conducive to healthy living!