June 27, 2013, 1:09 PM
Low Inflation Highlights Fed Dilemma
By Jeffrey Sparshott
The Federal Reserve is facing an inflation dilemma.
Inflation is running well below the Fed’s 2% target. Thursday’s reading on the Fed’s favorite inflation gauge showed prices up just 1.1% in May from a year earlier, matching the lowest pace on record.
Fed Chairman Ben Bernanke and other central bank officials maintain it’ll pick up. But a substantial band of economists outside the Fed is starting to challenge Mr. Bernanke’s diagnosis.
The Fed chief, in his press conference last week, said the downshift in inflation may reflect “transitory factors” that will dissipate. Those include a dip in medical payments and the cost of some services that don’t have traditional market prices, such as free checking accounts.
“These are some things that we expect to reverse and we expect to see inflation come up a bit,” he said. “That being said … we don’t take anything for granted.”
Fed governor Jerome Powell underscored the message in a speech Thursday, saying most Fed officials are looking through the temporary movements and expect inflation to return to 2% over the coming years. But he added, “Continued low or falling inflation could, however, raise real concerns. Inflation can be too low as well as too high.”
How inflation moves in the coming months will shape the central bank’s next steps. If inflation doesn’t rise close to the Fed’s target, Mr. Bernanke said the Fed might rethink its plan to begin scaling back the size of its bond-buying program later this year.
Overall inflation was 1% in May from a year earlier, the Commerce Department said Thursday. Core inflation, the Fed’s preferred measure that strips out volatile energy and food costs, rose 1.1% from a year earlier. That matched the previous month’s reading and equaled the smallest rise in underlying prices on record.
Some economists think more than temporary factors are behind the low inflation readings.
Goldman Sachs economist David Mericle said other components of underlying inflation also are close to historic lows. “This again suggests that low inflation is not confined to the components highlighted in the chairman’s press conference,” Mr. Mericle said in a note to clients this week. The firm’s economists are forecasting a modest recovery in inflation during the rest of 2013.
Medical payments are a key wild card. Automatic federal spending cuts, known as the sequester, imposed a 2% reduction on Medicare payments starting in April, easing price pressures. But other factors could have a longer-term impact, such as cheaper generic drugs coming to market and replacing more expensive name brand products, as well as the potential effects of the Affordable Care Act.
Declining government payrolls and tightening federal spending also could play a role in pushing inflation down.
“Government is shrinking and prices are responding,” said Laura Rosen, an economist at BNP Paribas. “I don’t see it as something to not be concerned about. Disinflation is disinflation.”
The latest set of government spending cuts “is the start of further, more structural changes that could influence stickier prices such as medical care,” she said.
Low inflation can help American households that have seen only tiny wage gains. But price increases that are too slow also carry risks, which Fed officials say they’re taking seriously.
“Inflation that’s too low is a problem,” Mr. Bernanke said. “It increases the risk of deflation. It raises real interest rates. It means that debt deleveraging takes place more slowly.”
The Fed chairman said the central bank could start to dial down its $85 billion-a-month bond purchase program later this year if the economy expands and inflation gradually rises as it expects.
That has already led to one dissent inside the central bank’s policy committee. St. Louis Fed President James Bullard said talk of winding down the bond buying is premature given low inflation.
Mr. Bullard in a statement said that “a more prudent approach would be to wait for more tangible signs that the economy was strengthening and inflation was on a path to return toward target” before announcing such a plan.
Inflation is running well below the Fed’s 2% target. Thursday’s reading on the Fed’s favorite inflation gauge showed prices up just 1.1% in May from a year earlier, matching the lowest pace on record.
Fed Chairman Ben Bernanke and other central bank officials maintain it’ll pick up. But a substantial band of economists outside the Fed is starting to challenge Mr. Bernanke’s diagnosis.
The Fed chief, in his press conference last week, said the downshift in inflation may reflect “transitory factors” that will dissipate. Those include a dip in medical payments and the cost of some services that don’t have traditional market prices, such as free checking accounts.
“These are some things that we expect to reverse and we expect to see inflation come up a bit,” he said. “That being said … we don’t take anything for granted.”
Fed governor Jerome Powell underscored the message in a speech Thursday, saying most Fed officials are looking through the temporary movements and expect inflation to return to 2% over the coming years. But he added, “Continued low or falling inflation could, however, raise real concerns. Inflation can be too low as well as too high.”
How inflation moves in the coming months will shape the central bank’s next steps. If inflation doesn’t rise close to the Fed’s target, Mr. Bernanke said the Fed might rethink its plan to begin scaling back the size of its bond-buying program later this year.
Overall inflation was 1% in May from a year earlier, the Commerce Department said Thursday. Core inflation, the Fed’s preferred measure that strips out volatile energy and food costs, rose 1.1% from a year earlier. That matched the previous month’s reading and equaled the smallest rise in underlying prices on record.
Some economists think more than temporary factors are behind the low inflation readings.
Goldman Sachs economist David Mericle said other components of underlying inflation also are close to historic lows. “This again suggests that low inflation is not confined to the components highlighted in the chairman’s press conference,” Mr. Mericle said in a note to clients this week. The firm’s economists are forecasting a modest recovery in inflation during the rest of 2013.
Medical payments are a key wild card. Automatic federal spending cuts, known as the sequester, imposed a 2% reduction on Medicare payments starting in April, easing price pressures. But other factors could have a longer-term impact, such as cheaper generic drugs coming to market and replacing more expensive name brand products, as well as the potential effects of the Affordable Care Act.
Declining government payrolls and tightening federal spending also could play a role in pushing inflation down.
“Government is shrinking and prices are responding,” said Laura Rosen, an economist at BNP Paribas. “I don’t see it as something to not be concerned about. Disinflation is disinflation.”
The latest set of government spending cuts “is the start of further, more structural changes that could influence stickier prices such as medical care,” she said.
Low inflation can help American households that have seen only tiny wage gains. But price increases that are too slow also carry risks, which Fed officials say they’re taking seriously.
“Inflation that’s too low is a problem,” Mr. Bernanke said. “It increases the risk of deflation. It raises real interest rates. It means that debt deleveraging takes place more slowly.”
The Fed chairman said the central bank could start to dial down its $85 billion-a-month bond purchase program later this year if the economy expands and inflation gradually rises as it expects.
That has already led to one dissent inside the central bank’s policy committee. St. Louis Fed President James Bullard said talk of winding down the bond buying is premature given low inflation.
Mr. Bullard in a statement said that “a more prudent approach would be to wait for more tangible signs that the economy was strengthening and inflation was on a path to return toward target” before announcing such a plan.
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