Inflation Remains Low, But Risks Remain

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If you subscribed to my online newspaper, econprofaj, you would have read that inflation remains low.  The Wall Street Journal’s Real Time Economics reports that inflation remains low for all developed countries.  Given the significant monetary stimulus by the U.S. and Europe, one would expect inflation to rise.  However, a tepid U.S. recovery and negative effects of austerity in Europe are making it difficult for producers to raise prices.

What does this mean?  Since the labor market is still performing below par in both the U.S. and Europe, both central banks will probably remain aggressive in using monetary policy to stimulate economic activity.  Within the U.S., the Federal Reserve is buying bonds in order to keep interest rates low to encourage more home buying.  As we have seen, home prices are on an upward trend.  That usually leads to a more robust recovery because people need to fill up their new house with appliances and furnishings.

That sounds great, but it is still wrought with risks.  While Fed Chairman Ben Bernanke says that they can easily reverse their bond purchases in order to stamp out rising inflation, that is not always easy.  What if there’s stagflation?  That occurs when the economy is not growing, but inflation is rising.  Any moves to stem inflation will only worsen the economy more because fighting inflation raises the interest rate.

Even if that does not occur, expansionary monetary policy usually devalues our currency.  While we might like that because exports will rise as a result, this would not be good news for emerging countries abroad, who will be faced with prospects of stronger currencies and less jobs due to lower exports.  That would threaten the overall global economy as economic turmoil would be a likely result.

What’s needed is some sort of fiscal stimulus, whether it is in the form of lower taxes or higher government spending.


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