Saturday, July 29, 2017

Why The Inflation Rate Is A Worry For The Federal Reserve

This is a story of what is not happening in the economy. What's not happening is inflation. You would expect a little bit more than there is given that there have been low interest rates for years, and there's a bit of economic growth. This is of interest to David Wessel, who is director of the Hutchins Center at the Brookings Institution, contributing correspondent to The Wall Street Journal and a regular guest here. Hi, David.

DAVID WESSEL: Good morning.

INSKEEP: OK, so it's not that there's no inflation, right?

WESSEL: Right. Basically, the Fed's favorite inflation measure shows that prices of all sorts have risen by only 1.4 percent over the past year. That's shy of their 2 percent target. And they've been shy of that target for much of the past decade. Now, a few months ago, as unemployment came down, inflation seemed to be creeping up. But lately, it's been a surprise. We have unemployment at a 16-year low. And the inflation rate has actually been coming down, not up. So that's both a surprise, and it's become a worry at the Federal Reserve.

INSKEEP: Why worry? Isn't low inflation good?

WESSEL: Well, look, first of all, you have to remember that every price you pay is someone else's income. So what the Fed is talking about is not just getting the prices you pay up but getting incomes and wages up more rapidly. But secondly, there's some economic problems with too little inflation.

One of them is this. When there's very little expected inflation, interest rates are very low - the ones in the markets. And when interest rates are very low, the Fed doesn't have much maneuvering room. If a recession hits, and it wants to cut interest rates to give the economy a boost, they don't really have much cushion to get the economy going again if we hit hard times.

INSKEEP: Why would the Fed raise interest rates, which is something you do to fight inflation, if there's hardly any inflation?

WESSEL: Great question. Look, many - not all, but many Fed officials figured that the last few months are an aberration. With unemployment so low and the economy doing better, there's just some temporary factors that are distorting the numbers. And so they basically say inflation is around the corner. Here's how Janet Yellen explained it in a recent congressional hearing.


JANET YELLEN: I do believe that part of the weakness is (ph) - inflation represents transitory factors, but we'll recognize inflation has been running under our 2 percent objective, that there could be more going on there.

INSKEEP: OK, what's the theory that there could be more going on there?

WESSEL: Well, one possibility is that the economy isn't nearly as close to full employment as the experts say - that there were enough people on the sidelines of the economy, who are now starting to look for work, that employers still don't have to give very many wage increases. Another one is that the economy has kind of changed some way. Maybe it's more competition from Amazon, weaker unions, the impact of globalization - something that just makes it harder to get wages and prices going up.

This is a global phenomenon. The European Central Bank has been frustrated that inflation there has been so stubbornly low. And the Bank of Japan has done everything that anybody could ever think of to get inflation up. It's managed to get prices rising at 0.5 percent a year. And it now says it doesn't expect to meet its 2 percent target until the year 2020.

INSKEEP: Well, David, now, we're getting to a subject that I know has been of great concern to you over the years - wage stagnation. I think what you're telling me is that it's possible that very low inflation, which sounds like a good thing, is just a symptom of stagnant wages continuing, which is a very bad thing.

WESSEL: Yes, when we talk about wage stagnation, we usually mean inflation-adjusted wages. But you're right. This is a symptom of an economy that just doesn't seem to have much zip.

INSKEEP: David Wessel nearly always has zip when he comes by. He's with the Hutchins Center at the Brookings Institution and The Wall Street Journal. David, thanks.

WESSEL: You're welcome.

- Source, NPR

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