Harvard’s Martin Feldstein warns US Inflation Is Running Above 2%

Inflation is a process which represents political actions that comes with economic consequences. And because money and credit creation operates in stages, this impacts relative sectors (first recipient of money) with relative price changes that eventually spreads through the system. In other words, since inflation is a process, they don’t just happen as the mainstream sees them. And they are hardly about just supply side problems.

In the US, inflationary pressures seen via the consumer price index has been inching higher. Some experts have seen this as approaching danger zone.

At the Wall Street Journal Harvard professor and former chairman of the Council of Economic Advisers under President Ronald Reagan Martin Feldstein warns of a possible surge in US inflation (bold mine)

Inflation is rising in the United States and could become a serious problem sooner than the Federal Reserve and many others now recognize. There are three basic reasons why the Fed is too optimistic in its current forecast that inflation will remain below its 2% target until after 2016.

First, data indicate that prices are already rising faster than 2% and have accelerated in recent months. Second, the low rate of short-term unemployment may be creating pressure for faster inflation despite the large total number of unemployed and underemployed individuals. And third, the rhetoric of Fed officials indicates that the central bank may not react quickly and aggressively enough if inflation continues to rise above 2%

This is the current conditions of US inflation as seen via PCE and CPI, charts from Doug Short

For the possible lagging effects on employment, let us tune back to Professor Feldstein

Will unemployment limit wage inflation? The unemployment rate is still a relatively high 6.3%, but an unusually large one-third of those who are counted as unemployed have been out of work for more than six months. Because the long-term unemployed are less connected with the active job market, they may provide less downward pressure on wage inflation. Recent research by Princeton's Alan Krueger and two of his colleagues indicates that wages respond to the number of short-term unemployed rather than to the total unemployment rate.

More specifically, the Brookings Institution study written with Mr. Krueger's Princeton colleagues Judd Cramer and David Cho implies that the unemployed who have been out of work for six months or more do not affect wage inflation. In contrast, wages begin to rise more rapidly when the unemployment rate among those out for less than six months declines to between 4% and 4.5%. Since the unemployment rate of those out for less than six months was only 4.1% in May, wages may soon begin to rise more rapidly.

Not everyone is convinced by this research. A more recent study by a Federal Reserve staff member suggests that the difference between the inflation effects of the long-term and short-term unemployed may only reflect recent experience and not be a good guide to the future. And William Dudley, president of the New York Fed, argues that the distinction between the effects of short-term and long-term unemployment depends on whether the long-term unemployment is cyclical or reflects structural and demographic changes that will limit their return to work even as markets tighten.

Is the Krueger research an accurate warning that labor markets are now closer to the threshold at which inflation begins to rise despite the substantial total number of people who aren't working? By the time we do know if he's right, it may be much more difficult to contain inflationary pressures.

I would add that wage inflation can already be seen via increases in minimum wages in several states.

 

From the National Conference of State Legislatures:

-38 states have considered minimum wage bills during the 2014 session; 34 states are considering increases to the state minimum wage.

-Connecticut, Delaware, Hawaii, Maryland, Michigan, Minnesota,  Vermont, West Virginia and D.C. have enacted increases so far in 2014.

What do all these imply? Well this should mean higher interest rates.

Yields of 10 year US notes appear to have partly been reflecting this.

The other implication is that since current US stock market record boom has been financed by deepening leverage, then higher rates will jeopardize the boom.

But don’t worry be happy, the ECB recently joined the bandwagon to produce inflation. So while this may in transient boost stocks, this will also COMPOUND on the growing inflation risks

And not only the ECB, a  newly published working paper by the IMF recommends more inflation to partly solve the debt problem

This paper investigates the impact of low or high inflation on the public debt-to-GDP ratio in the G-7 countries. Our simulations suggest that if inflation were to fall to zero for five years, the average net debt-to-GDP ratio would increase by about 5 percentage points over the next five years. In contrast, raising inflation to 6 percent for the next five years would reduce the  average net debt-to-GDP ratio by about 11 percentage points under the full Fisher effect and about 14 percentage points under the partial Fisher effect. Thus higher inflation could help reduce the public debt-to-GDP ratio somewhat in advanced economies. However, it could hardly solve the debt problem on its own and would raise significant challenges and risks. First of all, it may be difficult to create higher inflation, as evidenced by Japan’s experience  in the last few decades. In addition, un-anchoring of inflation expectations could increase long-term real interest rates, distort resource allocation, reduce economic growth, and hurt the lower–income households.

Inflation has always been seen as a magic wand by the government and by statists. 

They hardly consider the real socio-economic problems associated and or brought about by inflation. Venezuela should be a wonderful example.

Oh yes, please be reminded of the evils of inflation, again from chief inflation proponent John Maynard Keynes

Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some.

The unintended consequences of all these quasi permanent boom policies will emerge in due time...soon.