An Uneasy Economist on Inflation

The U.S. Bureau of Labor Statistics reported that CPI inflation was flat in April. That is, the change in consumer price index last month was 0.0%.

This led to a variety of reports about inflation easing, particularly as energy prices ease. For example, Bloomberg news reported: “A measure of the U.S. cost of living was unchanged in April, restrained by a drop in energy prices and supporting the view of some Federal Reserve policy makers that inflation will ease… Fed Chairman Ben S. Bernanke said on April 25 that a rise in gasoline prices ‘has created a temporary bulge’ in inflation that’s likely to ‘pass through the system.’”

We should be pleased, right?

Well, sorry, but looking ahead, I’m not so sanguine about inflation.

Keep in mind that inflation ultimately and always is a monetary phenomenon – i.e., too much money chasing too few goods, or money supply running ahead of money demand.

Given that reality, the Fed’s massive and unprecedented expansion in the monetary base that has occurred since September 2008 cannot simply be ignored or wished away.

We have seen some upticks in inflation, particularly from December 2010 to September 2011. And CPI inflation doubled from 1.5% in 2010 to 3.0% in 2011. Through the first four months of this year, CPI inflation ran at an annualized rate of 2.7%.

No reason exists for the U.S. to be experiencing inflation above 2%, other than misguided monetary policy. But given the Fed’s incredible looseness for more than three-and-a-half years, the threat of still higher inflation most certainly lurks.

The key factor that has kept inflation in relative check compared to where it could be is that banks have been sitting on unprecedented amounts of cash. That is, excess reserves stand at previously unimaginable levels (going along with the expansion of the overall monetary base (cash plus reserves).

The big question: What happens when those reserves start moving out of the vaults, if you will, and into the economy? That’s the biggest lurking threat regarding future inflation.

That threat, in turn, raises questions about the value of the dollar, and therefore, for example, the price of oil.

Ben Bernanke and his colleagues at the Federal Reserve seek to reassure us that the Fed can make a smooth exit from the excess reserves situation, though they also say that they have no real intention to shift policy looking all the way into 2014. But according to Bernanke & Company, we should not worry about inflation.

History and economics, however, tell this economist that the Fed’s timing is very rarely, well, timely, and that every reason exists to continue to worry about future inflation running even hotter.

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Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council. His new book is “Chuck” vs. the Business World: Business Tips on TV.