Ruminations, May 18, 2014
Is inflation on the horizon or not? It depends on who you ask.
Paul Krugman, economist and columnist for the New York Times, is scornful of those who are concerned about inflation. In fact, he believes that a cure for the economy is a fiscal program that would produce more inflation.
Can inflation be a problem? Of course it can, but Krugman is not worried. Neither is former Treasury Secretary Timothy Geithner who, in response to a question by Fox’ News Bret Baer, responded that the Fed can “absolutely” control inflation if it happens to occur – although he acknowledged that a one percent increase in interest rates would put interest payments higher than the budget for the Department of Defense.
Fed Chief Janet Yellen isn’t worried about inflation yet either. As the economy improves, she believes that people will return to the workforce and that will keep employment inflation non-existent. (The Fed relies on what is known as the Phillips Curve, which states that as unemployment goes up, inflation goes down and vice versa. However, former Fed Chiefs Alan Greenspan and Paul Volcker think that the Phillips Curve is a lot of hooey.)
It looks like the big guns aren’t worried about inflation so why should we be concerned? Well, it almost seems that for every economist’s opinion, there is an equal and opposite opinion. And so it is here.
Economist Martin Feldstein thinks that the Fed has been paying too little attention to inflationary risks. The late Milton Friedman said that when a nation has high monetary growth, as we have had, the risk of high “inflation is always and everywhere.” And economist Alan Meltzer last week wrote an op-ed in the Wall Street Journal entitled, “How the Fed fuels the coming inflation.”
Well! We have opinions that contradict each other and from knowledgeable economists. Maybe we need to consider what is happening in the real world. Krugman points out that inflation hawks have been concerned about inflation for years and there has not been significant inflation during that time. The Fed has been pumping money into the economy for years and there is little inflation. Could Krugman et alia be right?
They could … but they could also be wrong. In April, the consumer price index (CPI) jumped 0.3 percent – an annualized figure of 3.6 percent – and the producer price index rose 0.6 percent – three times what analysts expected. To be sure, that is only one month’s worth of data. On the other hand, the CPI increase is twice the Fed’s target (approximately 20 percent over 10 years), enough to prompt Greenspan to state “the presumption that [inflation is] no longer on the horizon … is a mistake.”
“Why is there such a weak response to such an enormous amount of stimulus, especially monetary stimulus?” Meltzer asked. While admittedly there was a large financial component to the Great Recession, the Fed has focused exclusively on that component – that’s the only area where they can have an impact. So the Fed printed more money, assuming that this semi-inflationary action would prompt economic expansion. Instead, businesses and lenders reacted to losses that the Great Recession inflicted upon them – and to the uncertainty of new Federal restrictions (such as the Dodd-Frank Act and the Patient Protection and Affordable Care Act). So, as the old aphorism says, “when your only tool is a hammer, every problem looks like a nail.” The Fed’s only tool was the money supply so they naturally increased it.
And then there’s the Keystone pipeline. Had construction begun when the pipeline was first approved, it would have been operational last January. Since it is not operational, oil producers have resorted to moving the oil via rail, causing a severe shortage of rail capacity. Last Wednesday’s Wall Street Journal reported that “The rail snarls have created a backlog in fertilizer supplies, raising fears that farmers … won't have adequate nutrients to sow corn, wheat and barley. At the same time, farmers have struggled for months to get enough rail capacity to ship grain harvested last year to processing plants.” And what effect do you think that this will have on food prices?
When the Fed’s policies fail, they look for excuses. Now, it must be admitted that the Fed policy of printing money has created inflationary pressures. But rather than saying that it hasn’t created jobs and stimulated the economy, they use excuses such as, “it would have been a lot worse without more fiat money,” or to blame one-time events (the cold winter, el Nino, the Japanese tsunami, the Greek bailout, the sequester or debt ceiling debates.) If and when things go well, there will be no excuses.
Who is right about inflation? Is it Krugman, Geithner and Yellen? Or, is it Feldman, Friedman and Meltzer? If you took a poll among economists you would find no consensus. Will the Fed policies lead, as some have suggested, to financial speculation, instability and inflation? “It’s premature frankly to jump to that conclusion,” Yellen remarked in a forum last month. But then she added, “There can be surprises.”
Quote without comment
Economist Allan H. Meltzer, writing in the Wall Street Journal, May 7, 2014: “Never in history has a country that financed big budget deficits with large amounts of central-bank money avoided inflation. Yet the U.S. has been printing money -- and in a reckless fashion -- for years.”