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Monday, June 27, 2011

The Fed's Inflation Optimism

In its policy statement released on June 22, the Federal Open Market Committee (FOMC) continued with its very optimistic take on inflation.

The FOMC statement included: "Inflation has picked up in recent months, mainly reflecting higher prices for some commodities and imported goods, as well as the recent supply chain disruptions. However, longer-term inflation expectations have remained stable." And later: "Inflation has moved up recently, but the Committee anticipates that inflation will subside to levels at or below those consistent with the Committee's dual mandate as the effects of past energy and other commodity price increases dissipate."

And the Fed is so confident that inflation is of little concern, that it will keep the fed funds rate at its unprecedented low, with a target range of 0 to ¼ percent.

In reality, though, substantial risks exist when it comes to inflation.

The Bernanke Fed, of course, has been running historically loose monetary policy since September 2008. And since inflation ultimately is a case of money supply running ahead of money demand, the inflation threat is very real.

In fact, inflation started accelerating in the second half of 2010. For example, over the past 12 months, CPI inflation registered 3.6%. And for the past six months, CPI inflation (seasonally adjusted) registered a 5.1% annualized rate.

Using a slightly different inflation measure (the price index for personal consumption expenditures), the Fed projects inflation of 2.3%-2.5% for 2011, 1.5%-2.0% for 2012, and 1.5%-2.0% for 2013 as well. That's wildly optimistic given the state of monetary policy.

The current economy is in a fragile state. The recovery has grossly under-performed; job creation has badly lagged; small businesses lack confidence; and inflation risks have increased. In effect, for a year now, the U.S. has been suffering a mini-bout of stagflation. The big risk is that stagflation grabs the economy with an even firmer grip.


Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council.

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