The FOMC’s Low-Inflation Worries

The minutes of the March FOMC meeting released yesterday, April 9, showed a heightened concern about the low and falling inflation rate. The FOMC’s favorite price index, the Personal Consumption Expenditure price index, increased only 0.9 percent over the past year. The Consumer Price Index increased only 1.1 percent in that time. The inflation rate in many European countries is even lower than that, and the European Central Bank is concerned as well. The IMF has also been sounding the alarm.

In my previous blog post, I discussed two reasons that central bankers are concerned about inflation getting too low. First, they fear that the closer inflation gets to zero, the more likely it is to slip below zero into deflation territory. A second reason is what central bankers call the “zero bound” problem. At very low rates of inflation, low nominal policy rates, like the federal funds rate, can’t produce real rates that are much lower. For example, with zero inflation, a zero policy rate is still not a negative rate that would be more powerful in stimulating spending.

In that post, I hinted at, but did not state explicitly another important aspect of the issue—that the public generally assumes implicitly that, if inflation were lower, they would still have the same amount of money to spend on goods, services, or financial assets. Decades of public speaking with Q&A sessions have convinced me that Ms. Yellen and company will have a hard time convincing the public that a little inflation is a good thing. It’s difficult for everyman to accept that the same inflation that deflates his purchasing power likely inflates his nominal income and assets available to use for purchases. Actually, it’s difficult for me to accept that. We all enjoy a little money illusion. That’s why it makes me cringe with the new Chairman of the Fed places so much emphasis on wanting higher inflation. Once people hear what she is saying, I think it will create unnecessary controversy.

Comments (3)

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  1. Alyson says:

    Greatly appreciate this post! A little inflation is not the enemy, especially if it keeps us out of a period of deflation. Avoiding deflation is key when determining interest rates.

  2. Emanuel H Rosen MD says:

    To my eye, this is a bit of a back track, but very helpful. So inflation is good but John Q. Public is too dumb to realize it because he only focuses on what it costs him and not what it does to his income. It is an image problem.

    But what if incomes are not really rising for the working middle class folk, but only for the ultra rich and the transfer payment recipients? The wrong people get screwed and real growth which is ultimately only achievable by real talent producing real value is reduced. And our country is ultimately slowly decayed and destroyed.

    Historians will look back at our intellectuals as myopic I suspect.

  3. Marvin McConoughey says:

    I am with J.Q. Public in fearing inflation. What the Fed wants, it may get too much of. Inflation harms people on a fixed income. Inflation has not been a consistent predictor of economic prosperity.Inflation has the sorry characteristic of (sometimes) concealing underlying problems temporarily when they should be confronted as they occur. Inflation may be easier to begin than to stop. I don’t agree that inflation is currently falling.