Soaring prices of many commodities have induced concerns that the U.S. economy could fall victim to inflation, but local economists say there’s little reason to believe the risk is serious.
The Federal Reserve’s loose monetary policy, namely its $600 billion bond-buying program and near-zero percent short-term interest rate, combined with soaring commodity prices, have made some believe that the country is looking at a return to 1970s-era inflation.
But high unemployment and spare industrial capacity should provide the economy enough slack to absorb the Fed’s credit-creating efforts, multiple local experts said, echoing the sentiments of Fed members in recent public speeches, and a report by the International Monetary Fund (IMF) released April 11.
“People who say we’re going to have an inflation explosion don’t know what they’re talking about,” said Dan Seiver, professor of economics at San Diego State University. “There’s a lot of slack in the economy and the labor market. I don’t see a wage-price spiral.”
Lynn Reaser, chief economist at the Fermanian Business and Economic Institute at Point Loma Nazarene University, said there’s likely little to no risk of inflation, but warned that the Fed has been historically late in reacting to changes to labor cost.
“I think there’s greater risk than might be the view of [Olivier] Blanchard, [IMF chief economist], or some of the leading officials at the Fed, including Chairman Bernanke,” she said. “The threat would be that we have less excess capacity than is estimated, because those numbers are arrived at through a great deal of judgment.”
Inflationary fears are based on the rise in headline inflation, or measures of commodity prices that include the volatile food and energy sectors.
As of the end of March, the consumer price index (CPI) increased 2.7 percent from a year earlier.
However, core inflation — the price of commodities excluding food and energy — was up only 1.2 percent from last March, well below the Fed’s target of 2 percent.
Richard Carson, professor of economics at the University of California at San Diego (UCSD) said central banks typically pay more attention to core inflation, because it’s a better indication of what’s happening in the economy.
Shocks to oil and food costs have come from a combination of unpredictable world events, such as the Japanese tsunami and unrest in the Middle East, and growth in the developing world.
“The movement in prices has less to do with anything the Fed has done, and more to do with international factors, namely the situation in Libya and demand in industrialized countries,” said James Hamilton, professor of economics at UCSD.
Reaser said the Fed’s exit from its policy of extreme monetary ease would be more important to the state of inflation than any threat posed by commodity prices.
“The Fed has historically moved too late in easing and tightening, given lags in changes to policy and its effects on growth and inflation,” she said. “They could again be too late in the current cycle.”
Seiver disagreed, saying the Fed’s balance sheet isn’t relevant to questions of inflation.
“If they see signs of inflation, they can just empty their balance sheet,” he said.
Still, Reaser agrees with the prevailing consensus that the underlying rate of inflation will remain benign in the near term, due to productivity gains in the labor market and restrained wage increases.
Recent public speeches by Janet Yellen, the Fed’s vice chairwoman, and William Dudley, the president of the Federal Reserve Bank of New York, indicate the Fed will continue its bond-buying program through its scheduled June completion. The central bank is also expected to maintain a short-term interest rate near zero percent through the end of the year.
The Fed had been justifying its expansionary monetary policy by pointing to concerns of deflation and decreases in the price level. Deflation is now a remote possibility, according to Hamilton, which eliminates one of the Fed’s arguments for its approach.
He said he’d be very surprised if rates were raised before early 2012.
“The earlier question is, what are they going to do with the asset purchases?” he said. “Are they going to follow through with QE2 [its second round of quantitative easing], or let asset holdings diminish as mortgages are paid off? That’d be the first place we see a change in Fed thinking, before raising interest rates.”
Early in April, the European Central Bank raised its short-term rate a quarter of a percentage point to 1.25 percent, looking to combat potential inflation, which was above the bank’s target 2-percent rate. Between that and the actions of central banks in emerging markets taking similar action, the U.S. and Japan are now alone in their pursuit of expansionary policies.
Being among the last central banks with unusually loose monetary presents concerns over the value of the dollar, Reaser said.