Inflation defies the Fed
April 18, 2012
The Consumer Price Index figures released Friday suggest that inflation may be more of a problem than the Federal Reserve would like to admit. The Bureau of Labor Statistics (BLS) reported Friday that the CPI increased by 0.3 percent in March. Taken together with February's figure, that makes for an increase of a little over 0.7 percent in just two months, which projects to an inflation rate of more than 4 percent annually.
One of the troubling things about inflation is that it can start to generate its own momentum, as prices in one sector react to increases in another. In the case of the March CPI figures, the fastest-rising component was gasoline prices.
Even though crude oil prices started to ease in March, the gasoline component of the CPI has still risen by 9 percent in the past year. This suggests that a degree of price momentum has taken hold with gas prices, and that can quickly infect many other sectors of the economy.
The Fed's position
The Fed's mission is to balance two goals: managing economic growth and keeping inflation under control. Currently, it has dug in its heels on the position that inflation is not a problem, and therefore all its policies have been geared towards stimulating growth. This is why it has maintained extremely low short-term interest rates, and has taken unusual measures to bring down long-term rates as well.
The problem is, the inflation numbers are starting to defy the Fed's position. The Fed will certainly be able to dismiss a couple months' worth of inflation numbers, but if these higher price increases persist, the Fed will have to react.
Reduced spending power
Not only is inflation challenging the Fed's mission of keeping prices under control, but under the present circumstances it could also foil the Fed's efforts at stimulating the economy, because rising prices can smother consumer spending power.
Already, people depending on savings accounts and similar forms of income have seen their earnings reduced to a fraction of what they were a few years ago. Having prices rise while savings rates fall only exacerbates the problem.
Also, average hourly wages have not been able to keep up with the rise in inflation. The BLS reported that hourly wages increased by just 0.2 percent in March, compared with the 0.3 percent increase in inflation. Over the past year, average hourly wages have fallen behind inflation by 0.6 percent.
When consumers can afford to buy less because savings account rates and wages are failing to keep up with inflation, it means less economic growth. In other words, if the recent inflation trend keeps up, the Fed will have not only failed to control price increases, but it could also fall short of accomplishing what it has been chiefly focused on, which is stimulating growth.