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Measured inflation is still benign




I've been worrying about rising inflation for most of the past year, mainly because of the Fed's extremely accommodative monetary policy (e.g., zero interest rates, plus the injection of over $1 trillion of reserves to the banking system in exchange for mortgage-backed securities). My concerns have not been unfounded. When I look at sensitive indicators of the net effect of monetary policy, I see abundant evidence that there is an excess supply of dollars in the world: the dollar is within 5% or so of its all-time lows against other currencies; gold prices have risen from $260 to $1100/oz.; TIPS 5-yr forward breakeven spreads have risen from almost zero to 2.7%; the Treasury yield curve is as steep as it's ever been; credit spreads have narrowed significantly across the board; and commodity prices are up steeply across the board.

Yet as the chart above shows, measured inflation is within the Fed's target zone of 1-2%, as measured by the Personal Consumption deflator (February figures, included in the chart, were just released today). Am I wrong to worry about rising inflation?

I must admit that I thought inflation would be higher by now, but then I've never called for anything more than a "gradual rise in inflation," so I'm not off by too much. As Milton Friedman counseled, the lags between monetary policy and inflation are long and variable, so I take some comfort from that and am content to wait longer before throwing in the towel.

UPDATE: I would dearly love to be wrong on my rising inflation call. I really hope the Fed will not again make the mistake of keeping interest rates too low for too long, as they did from 2003-2005. Inflation is very unkind to the poor, the innocent, the trusting, and the naive, and it has wreaked havoc in most of the world's economies from time to time. Given the beating the economy is taking from Obama's wanton spending proclivities (which unfortunately greatly overshadow the Bush administration's excesses), higher inflation is the last thing we need right now.

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