The Economy: Continuing Good News on Inflation – Now and Looking Ahead?

By at 14 March, 2019, 3:31 pm

by Raymond J. Keating-

Economic growth is good for keeping inflation in check, and low inflation is good for economic growth. If you’re looking for a virtuous cycle in the economy, this would be it.

For the U.S., the recent and long-run stories on inflation have been positive.

According to the U.S. Bureau of Labor Statistics’ latest report on the Consumer Price Index, CPI inflation registered 0.2 percent in February, following three straight months of the CPI being flat. In fact, inflation basically has been nonexistent for the most recent seven months.

Historical Look Back

Looking back over longer periods, tame inflation has been the reality for the previous seven years (from 2012 to 2018), and the U.S. has an incredible low-inflation streak – with an exception of a year here and there – for a quarter century.

After the ugly inflation of the 1970s and very early 1980s, it really took almost a decade to ring out the remnants of that inflationary mess. But ever since, the U.S. has only had six years out of 25 in which inflation hit or moved above 3 percent. And in four of those years the U.S. suffered either from recession, below-average growth, or dramatically slowing growth.

For good measure, it pays to keep in mind that the worst inflation years of the 1970s and early 80s also were years of recession or poor/slowing growth.

Inflation registered 11 percent in 1974 and 9.1 percent in 1975. Real GDP growth during those years were -0.5 percent and -0.2 percent, respectively. Inflation came in at 7.6 percent in 1978, 11.3 percent in 1979, 13.5 percent in 1980, 10.3 percent in 1981, and 6.2 percent in 1982.

At the same time, real GDP ran at 5.5 percent in 1978, 3.2 in 1979, -0.3 in 1980, 2.5 in 1981, and -1.8 in 1982. So, from 1978 to 1982, inflation averaged 9.8 percent, while economic growth averaged 1.8 percent.

Economics 101

The idea that inflation results from an “overheating economy” has always been off base. Rather, Economics 101 tells us that inflation results from too much money chasing too few goods. Or another way to put it, money supply outruns money demand. Hence, we see inflation move up when growth slows down. And on the flip side, inflation undermines growth by acting as a tax that eats away at the value of the dollar, creates price volatility and uncertainty, and increases non-indexed forms of taxation, such as the U.S. capital gains tax.

One of the most striking economic policy developments over the past 10-plus years is that the Fed has had nothing to do with keeping inflation in check.

As we know, the Fed pushed the monetary base to levels never imagined before, and yet inflation has not ignited. Instead, bank reserves have mounted, again, to previously unimagined levels. So, the Fed’s loose monetary policies failed to spread into the economy. That points to the private market working against the mistakes of the Fed. Of course, the Feds’ misguided policies have had negative effects by creating uncertainty. But it obviously could have been much worse.

So, if the productive work in private markets of working to limit the Fed’s errors persists (and there’s no guarantee that it will), that offers the possibility of continued good news for the U.S. economy on inflation in the years to come. Indeed, the biggest threat regarding the possibility of higher inflation remains slow growth or recession.


Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council.

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