Inflation Update

Conventional wisdom today is that the threat of inflation is low, despite the Fed’s easy money policy, and notwithstanding some economists in the minority (I’m in that minority) who see the Fed’s easy money policy as laying the groundwork for inflation. The March Consumer Price Index (CPI) numbers were recently released, so let’s see what they have to say.

One way to evaluate inflation is to compare it to the Fed’s two percent target rate. Using their own goal as a benchmark, how are they doing? Year over year, from March 2011 to March 2012 the inflation rate was 2.7 percent, well above the Fed’s target, but lower than the 3.2 percent rate of inflation for the year of 2011. This makes it appear that inflation is declining, but the annual numbers are misleading because there was fairly rapid inflation early in 2011, followed by level prices (as measured by the CPI) later in the year.

For the first three months of 2012 prices have risen at an annual rate of 6.6 percent, so we appear to be on track for higher inflation. Looked at another way, prices have risen 1.65 percent in the first three months of 2012, so if the Fed is to hit its annual target for the entire year, the CPI can only rise another 0.35 percent in the next nine months. We can be pretty sure that won’t happen.

One reason Mr. Bernanke gave for announcing the two percent inflation target in January was to reduce uncertainty and anchor expectations about future inflation rates. But if the Fed is unable to meet that target — and it seemed to me at the time they would not — then by year-end the announced target will create more uncertainty and reduce the Fed’s credibility. The recently-released March inflation numbers point toward an annual inflation rate well above the Fed’s target.