After offering some tough talk on inflation and the dollar only a couple of weeks prior, Ben Bernanke & Co. (save for FOMC member Fisher) punted again this week on interest rates, on the rationale that growth remains weak and that "inflation is expected to moderate later this year and next year." Consumers stung at the pump, fleeced at the grocery store and struggling to pay utilities with rebate checks must be scratching their heads wondering how the Fed could look at all the available data and conclude inflation will soon abate. The answer is simple: the Fed focuses on core inflation, which excludes food and energy. Unfortunately, consumers have seen prices for these two components soar and spending on these goods account for more than 17 percent of disposable income-the highest share since 1991.

Yes, energy and food prices are volatile on a month-to-month basis. Nonetheless, since spending (as a share of income) on these goods was flat for nearly a decade, the Fed ought to at least factor them into the inflation expectations equation. Even if they aren't, consumers certainly are. According to the Conference Board, U.S. consumers expect inflation will average nearly 8 percent over the next 12 months. Although this is a bit excessive, likely traced back to the shock when filling up the gas tank, the mere fact that this metric has risen so much since last fall (hitting a 20-year high) suggests inflation is at the front of consumers minds.

The Fed has been afforded some temporary flexibility in preventing inflation expectations from becoming unmoored, mostly thanks to a lackluster job market. Accelerating inflation at the consumer and wholesale level, combined with negative real short-term interest rates, have left Fed Chairman Bernanke in a tight spot: maintain low rates and accept higher inflation (and a flagging dollar) or hike rates and risk killing future economic growth.

On the bright side, at least inflation hasn't gotten to the point where a bottle of beer costs $64 billion.


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