STOP THEM BEFORE THEY KILL AGAIN:

Easy money: Is America’s Federal Reserve running risks with inflation? (The Economist, Jan 30th 2004)

[C]oncerns that inflation is about to pick up are probably overdone. For one thing, inflation is currently too low. Over the past 12 months America’s core consumer-price index (ie, excluding food and energy) rose by only 1.1%, and the Fed’s favourite measure of inflation, the core personal consumption expenditure deflator, by only 0.8%—the smallest rise in the 45-year history of that index. This is well below most estimates of the Fed’s desired rate of inflation of 1.5-2%. So the Fed would be happy if inflation rose a bit.

On present trends inflation could even fall further. Inflation is not driven by the rate of growth, but by the amount of slack in the economy. When output is below its potential, inflation tends to fall even if growth is brisk. Goldman Sachs estimates that America’s GDP growth is still almost two percentage points below its potential.

There is more evidence of slack in the labour market, where weak demand for new workers is helping to hold down wage growth. Average wages have risen by only 2% over the past year and are unlikely to pick up by much until the unemployment rate, currently 5.7%, falls to 5%. Meanwhile, productivity has surged by 5% over the past year, resulting in a sharp drop in unit labour costs. This is another reason to expect inflation to edge lower over the next year.

The Fed is threatening to raise already historically high real rates into the teeth of deflation.

Posted by Orrin Judd at February 2, 2004 8:01 AM