Give inflation fears a rest
By Bob Landaas
For years, people have been fretting that inflation was going to skyrocket because of the financial bailout, because of quantitative easing, because of all sorts of reasons.
It’s time to give those fears a rest.
The worry that I have had wasn’t whether inflation was going to go up or whether interest rates were going to rise. I kept worrying what if inflation – and with it, interest rates – went down and just stayed down?
I’ll be darned if that’s not what happened. Interest rates fell, and they stayed down.
That presents a whole different set of problems to worry about.
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The big question that economists face right now is why isn’t inflation going up in the United States? That was the topic in Jackson Hole in August at the annual economic symposium sponsored by the Federal Reserve Bank of Kansas City.
Since 2012, the Fed has had a target of 2% inflation. They haven’t been able to get it there – not even with exceptionally low interest rates and three rounds of quantitative easing. The Consumer Price Index shows annual inflation at just 1.8% in August. If you include food and energy prices, the inflation rate is 0.2%.
Congress created the Federal Reserve with the primary mandate of price stability – to make sure that inflation doesn’t get out of control. We are rightfully phobic about inflation because once that genie gets out of the bottle, it’s really tough to get it back in.
Another mandate for the Fed is to maximize employment. For years, economists were telling us that an unemployment rate of 5% was about the point of full employment. For years, we thought that if we got to 5% unemployment, the Fed should raise interest rates because inflation would be right around the corner.
Unemployment stayed at 5.1% in September for the second month in a row, and still, inflation is nowhere to be seen.
Three factors create inflation:
- Wages. Year-to-year wage growth is now half of the long-term average. And there are still plenty of people out of work, so wages haven’t been going up.
- Raw materials. Every major commodities group has plunged in price since the spring of 2014. Oil prices are half where they were a year ago.
- Capacity. In the United States, 22% of the plant and equipment is sitting idle, although some of that is obsolete. The nation’s capacity utilization rate is 3% below its long-term average. Inflation pressure from overseas is even weaker. In China, the world’s second-largest economy, more than 40% of the production capacity is idle.
It’s all about interest rates and earnings. Interest rate are not about to skyrocket. They can’t. There is no inflation to speak of. If wages aren’t growing and if commodities are going down and there’s plenty of capacity, inflation can’t go up.
The Fed said at its September meeting that it is not ready yet to raise interest rates. It could still raise them when it meets in October or December. Or it could keep kicking that can down the road because it does not to have worry about controlling inflation.
At some point, the Fed wants to raise rates from historic lows to signal that the economy can grow on its own again and no longer needs support from the Fed. For months, the Fed has been saying that it is close to sending that signal.
For now, though, interest rates are dragging along the bottom, and I think that’s what we’re going to be looking at for a while.
This is one of the longest economic expansions in U.S. history. The financial crisis is still fresh in everyone’s memory, but at more than six years, this is already nearly double the length of the average expansion since 1854.
What I like about this expansion is that the normal restraints that create downturns aren’t apparent. Interest rates are low. Inflation is low. We have plenty of capacity. There are plenty of commodities. There is plenty of labor.
You look at barriers or obstacles to growth. You look at resistance levels. Ultimately, we create them during boom times, but I think slow and steady wins the race. I think we’ve still got some room to grow.
Bob Landaas is president of Landaas & Company.
(initially posted Oct. 1, 2015)