The United States has a problem: not enough inflation.
That notion is a bit of a headscratcher. Most people don't like inflation. They would prefer that a dollar tomorrow be worth the same as a dollar today.
But a recent drop in inflation may be a sign of fresh economic weakness, and it is perplexing to Federal Reserve officials who are now wrapping up the central bank’s stimulus campaign.
The Federal Reserve thinks modest inflation has important economic benefits, and it has aimed since 2012 to keep prices rising at an annual pace of 2 percent. The problem is that the Fed is on track of fail for the sixth straight year. Inflation has been stubbornly sluggish.
A little inflation can brighten the economic mode, causing wages and corporate profits to rise more quickly. Economists like to point out that this is an illusion. If everyone is making money, then no one can buy more stuff. Prices just go up. But the evidence suggests people enjoy the illusion and, what is important, they respond to the illusion by behaving in ways that increase actual economic growth － for example by working harder.
The Fed’s chairwoman, Janet L. Yellen, told Congress this month that she expected inflation to rebound. But she said the Fed could change course if weakness persisted, by, for example, not moving forward with additional interest increases.
“It's premature to reach the judgement 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.”
The Fed’s policy-making committee was to meet this week, but it was expected to defer major decisions until later in the year. Analysts expect the Fed to announce in September that it will start to reduce its holdings of Treasuries and mortgage bonds. The Fed is expected leave its benchmark interest rates unchanged at least until December.
That notion is a bit of a headscratcher. Most people don't like inflation. They would prefer that a dollar tomorrow be worth the same as a dollar today.
But a recent drop in inflation may be a sign of fresh economic weakness, and it is perplexing to Federal Reserve officials who are now wrapping up the central bank’s stimulus campaign.
The Federal Reserve thinks modest inflation has important economic benefits, and it has aimed since 2012 to keep prices rising at an annual pace of 2 percent. The problem is that the Fed is on track of fail for the sixth straight year. Inflation has been stubbornly sluggish.
A little inflation can brighten the economic mode, causing wages and corporate profits to rise more quickly. Economists like to point out that this is an illusion. If everyone is making money, then no one can buy more stuff. Prices just go up. But the evidence suggests people enjoy the illusion and, what is important, they respond to the illusion by behaving in ways that increase actual economic growth － for example by working harder.
The Fed’s chairwoman, Janet L. Yellen, told Congress this month that she expected inflation to rebound. But she said the Fed could change course if weakness persisted, by, for example, not moving forward with additional interest increases.
“It's premature to reach the judgement 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.”
The Fed’s policy-making committee was to meet this week, but it was expected to defer major decisions until later in the year. Analysts expect the Fed to announce in September that it will start to reduce its holdings of Treasuries and mortgage bonds. The Fed is expected leave its benchmark interest rates unchanged at least until December.
“If you see inflation running below target persistently, for so long, it's really hard to get around the idea that, despite everything, monetary policy has actually not delivered sufficient accommodation,” said Peter Ireland, an economist at Boston College. “It's a reason not to clamor for additional rate hikes on top of what we've already seen.”
The United States learned to fear inflation in the 1970s. It was a period of profound economic uncertainty. Prices rose up to 10 percent a year, and restaurants used stickers to update prices on menus. High inflation encouraged people to borrow heavily and spend quickly; it discouraged long-term planning and investment, and corporate profits fell sharply.
Under Paul Volcker, the Fed gradually brought inflation under control by driving the economy into a deep recession. By the mid-1990s, it seemed plausible that the Fed could eliminate inflation completely. But Ms. Yellen, then a new Fed governor, was among those who argued successfully that it would be better to maintain moderate inflation.
A little inflation helps the economy rebound from recessions. It giver the Fed more room to reduce borrowing costs, and it also eases necessary economic adjustments. Employers, for example, can cut cost by holding wage increases below the inflation rate.
Inflation can also brighten the economic mood by raising wage and profits more quickly.
And a little inflation also keeps the economy at a safe distance from deflation. When prices fall, growth tends to stall as people wait for even lower prices.
The current debate, however, is mostly about inflation’s role as an economy barometer.
The United States learned to fear inflation in the 1970s. It was a period of profound economic uncertainty. Prices rose up to 10 percent a year, and restaurants used stickers to update prices on menus. High inflation encouraged people to borrow heavily and spend quickly; it discouraged long-term planning and investment, and corporate profits fell sharply.
Under Paul Volcker, the Fed gradually brought inflation under control by driving the economy into a deep recession. By the mid-1990s, it seemed plausible that the Fed could eliminate inflation completely. But Ms. Yellen, then a new Fed governor, was among those who argued successfully that it would be better to maintain moderate inflation.
A little inflation helps the economy rebound from recessions. It giver the Fed more room to reduce borrowing costs, and it also eases necessary economic adjustments. Employers, for example, can cut cost by holding wage increases below the inflation rate.
Inflation can also brighten the economic mood by raising wage and profits more quickly.
And a little inflation also keeps the economy at a safe distance from deflation. When prices fall, growth tends to stall as people wait for even lower prices.
The current debate, however, is mostly about inflation’s role as an economy barometer.
