Inflation Worries Appear Overblown, for Now
The Federal Reserve’s massive quantitative easing program and efforts put in place by the Fed and Treasury to combat the financial crisis have raised fears that inflation will soon accelerate. While some fears are warranted, the near-term threat from inflation is likely overstated. Considerable excess capacity exists today and very few firms have any significant pricing power. Discounting remains rampant, rents are falling and wages and salaries are growing much slower.
Rising commodity prices and the weaker dollar could pave the way to higher inflation down the road, but even here the threat appears to be far less than widely thought. Commodity prices make up only a tiny fraction of the final sales price of most goods and recent price gains follow the unusually sharp slide that accompanied the onset of the financial crisis. The falling dollar is likely producing more of an inflationary threat due to the pass-through to import prices, but evidence appears to be modest.1 While these factors can still affect overall prices, they are being offset by moderating prices elsewhere.
Housing costs are another notable area of disinflation. With housing in obvious oversupply, rent and owners’ equivalent rent should continue to moderate for a least another year. These two components account for 39 percent of the “core” CPI, which means the “core” CPI, which is currently up just 1.5 percent year to year, will likely continue to moderate through all of next year. We expect the year-to-year change in the “core” PCE deflator, the Fed’s preferred inflation measure, to bottom at around 1.0 percent around the end of next year. This low rate of inflation will give the Fed flexibility to keep short-term interest rates low.
