While inflation may seem like an all-evil, harmful entity that all healthy economies should be bereft of, this is not always the case. The popular maxim 'nothing is good in excess' perfectly justifies why the Fed is currently worried about increasingly low inflation rates in the U.S., which could lead it to stall adopting a tighter monetary policy.
The Fed's ideal inflation rate is 2%. Inflation can decrease purchasing power, and if it is employed in moderation, it ensures that the American currency doesn't lose its value over time; sufficient demand for the dollar is maintained. Moreover, rising prices can produce a 'money illusion' that actually stimulates economic growth by increasing the incentive to work, which augments productivity. The result would ultimately be higher levels of profit and disposable income.
The fact that current inflation rates are bordering on around 1%, almost half of the Fed's target, warrants serious attention. This attention has taken the form of the "start of the process of reducing the Fed's $4.5tn balance sheet" as well as "not moving forward with additional interest rate increases."
The Fed's chairwoman Janet Yellen stated earlier this month that the decreasing rate of inflation could be attributed to temporary factors that would eventually be offset by lower unemployment. However, the prolonged decline has rattled not only the Fed, but also economists nation-wide.
"In the past, Yellen was pretty confident that inflation would come back, but that is now in doubt," said Sung Won Sohn, economics professor at California State University-Channel Islands.
"It's premature to reach the judgment that we're not on the path to 2 percent inflation over the next couple of years," Ms. Yellen said. "We're watching this very closely and stand ready to adjust our policy if it appears the inflation undershoot will be persistent."
Yellen associates the waning inflation with decreasing prices of products such as prescription drugs and cellular data plans for mobile phones. This should, however, have the counter effect of yielding more disposable income to spend on other goods, which should stimulate inflation. Moreover, the low inflation rates could also be the result of the global economy being weak and the U.S. therefore being able to import products for cheaper, allowing money to be funneled out of the country.
Another interesting take on the situation is that low inflation has become characteristic of developed nations due to the rise of developing countries with high growth rates. These countries, like China, have become popular places for multinational corporations to outsource their labor to, which inevitably keeps local wage rates pressed down. In that same vein, cheaper goods that can be imported from abroad thus also ensures that native prices remain stable and do not rise, as demand is equalized if not completely quelled.
It still remains to be seen if this irregular inflation pattern will persist, but the Fed must decide its course of action quickly: its policy-making committee meets on Wednesday. If it doesn't act soon, the problem could very well spiral out of control, especially because it has come as a surprise.
- https://www.ft.com/content/0b16c1b4-6f56-11e7-aca6-c6bd07df1a3c
- https://www.ft.com/content/cd6a1f41-809d-34c3-b244-356686407643?mhq5j=e1
- https://www.nytimes.com/2017/07/24/us/politics/us-inflation-remains-low-and-thats-a-problem.html
- https://www.usnews.com/news/business/articles/2017-07-24/fed-will-likely-focus-on-low-inflation-but-leave-rates-alone