What About Inflation?
By SBE Council at 18 November, 2016, 10:44 am
by Raymond J. Keating-
Are inflation concerns seeping back into our economic psyche?
On November 17, the Bureau of Labor Statistics provided a look at October CPI inflation. The Consumer Price Index rose by 0.4 percent in October. And over the past three months, we’ve seen a climb in CPI inflation, from being flat in July to a 0.2 percent rise in August, 0.3 percent in September, and October’s 0.4 percent.
Of course, at the same time, these numbers tend to be rather volatile from month to month, and in fact, over the past year, inflation has crept up by a mere 1.6 percent.
For good measure, since inflation spiked to 3.0 percent in 2011, it’s subsequently been basically non-existent, in any significant economic sense since, with December-to-December inflation registering 1.7 percent in 2012, 1.5 percent in 2013, 0.8 percent in 2014, and 0.7 percent in 2015. That, by definition, is price stability.
At the same time, throughout this time of price stability, uncertainty about monetary policy and its effects have run high. That’s quite a paradox. Indeed, uncertainty has been the rule since the credit mess hit hard in late summer 2008.
Why the uncertainty? Because of the Federal Reserve running monetary policy so loose that there is no precedent for it in U.S. history. As noted in a June 2016 SBE Council analysis titled The Real Story of the Fed’s Loose Money:
The critical point to keep in mind is that the vast expansion in the monetary base by the Fed since September 2008 has overwhelmingly translated into a massive, unprecedented expansion in excess bank reserves (that is, reserves in excess of the reserve requirement set by the Fed). The monetary base went from $875 billion in August 2008 to $3.9 trillion early this month. Meanwhile, excess bank reserves have moved from a mere $1.9 billion in August 2008 to $2.3 trillion in early June 2016. That means more than three-quarters of the increase in the monetary base has merely sat as excess bank reserves.
To further drive home this point, a February 2015 analysis of excess reserves by the Cleveland Fed noted, “From 1959 to just before the financial crisis, … excess reserves as a percent of total reserves in the banking system were nearly constant, rarely exceeding 5.0 percent. Only in times of extreme uncertainty and economic distress did excess reserves rise significantly as a percent of total reserves; the largest such increase occurred in September 2001.” Consider that not only have reserves skyrocketed over the last eight years, but excess reserves as a share of total reserves now come in at 95 percent.
In addition to this bit of acceleration in inflation in recent months, assorted talking heads have declared concerns about President-elect Donald Trump’s policies leading to inflation. Assuming that Trump’s policies will generate faster economic growth, these people buy into an old economic falsehood that more growth means more inflation.
Economic Realities about Growth and Inflation
Let’s get a few things clear.
First, economic growth does not cause inflation.
Second, increased wages do not cause inflation.
Third, inflation is a monetary phenomenon, with the classic definition being that inflation results from too much money chasing too few goods. Therefore, it is important to understand that increased economic growth, i.e., the production of more goods and services, if you will, actually works against inflation.
This brings us back to the uncertainly long looming around monetary policy. The risk for increased inflation lies with the aforementioned unprecedented level of bank reserves. If those reserves begin moving into the economy at an accelerated pace, that’s where inflation will materialize from ultimately.
When it comes to monetary policy, we have been in uncharted waters for more than eight years now, and quite frankly, no one can confidently predict what’s coming next as we apparently get ready to make some serious changes in terms of, for example, tax and regulatory policies.