Welcome Downshift in Inflation: Fed Getting Back on Right Track

By at 13 June, 2019, 7:34 am

by Raymond J. Keating

The latest Consumer Price Index news from the U.S. Bureau of labor Statistics (BLS) offered a welcome downshift in inflation.

CPI inflation, after being low for several months, took a jump higher in March and April of this year, hitting 0.4 percent in March and 0.3 percent in April. As we noted, “in trying to detect a trend” on inflation, “it must be noted that the numbers from month to month can be very volatile.” Our suggestion was: “So, in general, the good news on tame inflation holds – though with the caveat that at least one eye be kept on the CPI and other inflation data to make sure that these last two months of data do not develop into a trend.”

And now we see that the CPI rose by only 0.1 percent in May.

For good measure, the BLS reported, “Over the last 12 months, the all items index increased 1.8 percent before seasonal adjustment.”

There are good reasons why the job of any central bank, such as the Federal Reserve, is to maintain price stability as best it can. Besides the fact that the Fed is ill-equipped to, and usually gets into trouble when focusing on goals other than price stability, standing vigilant against inflation is important because of the destructive nature of inflation. Inflation is a tax in that it eats away at the value of the currency. Inflation creates uncertainty, especially since periods of higher inflation also tend have wild swings in inflation. For good measure, inflation raises taxes when such levies are not indexed for inflation, such as is the case with the capital gains tax. The list goes on.

Interestingly, the Fed over the past 11 years has had very little to do with our low levels of inflation. Indeed, the Fed’s historic expansion in the monetary base (currency plus bank reserves) created uncertainty and considerable risks for inflation. What saved us? Well, bank reserves skyrocketed to unprecedented levels. That is, the Fed’s loose money never made it into the economy.

Source: Federal Reserve Bank of St. Louis, FRED

Unfortunately, uncertainty persists, which is why the Fed has been wise since the latter half of 2014, but particularly since late 2017, in beginning the process of reining in the monetary base (as noted in the chart above).

The following chart also makes clear that even with its more recent increases in the federal funds rate, that interest rate remains historically low.

Source: Federal Reserve Bank of St. Louis, FRED

For the most part, the Fed’s recent work has been constructive in trying to clean up the uncertainty created by unprecedented loose Fed policy that started in the summer 2008.


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

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