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The Federal Reserve must be prepared to prevent a surge in inflation that may be sparked by the stimulus policies implemented during the credit crisis, according to a Federal Reserve Bank of St. Louis report.
“What’s needed is an effective policy to prevent the unprecedented monetary stimulus from becoming a destabilizing influence on price stability,” St. Louis Fed economist Kevin Kliesen wrote in an article last week titled “Inflation May Be the Next Dragon to Slay.”
Disagreement among economists on the inflation outlook can signal an imminent rise in prices, Kliesen wrote, citing forecasts in the past five years of the average consumer price index inflation rate. Since early 2007, the level of disagreement among forecasters on the inflation outlook has “increased sharply,” he said.
Fed officials differed last month on the outlook for consumer prices, according to the minutes of the Federal Open Market Committee’s Dec. 15-16 meeting released Thursday. Some officials said “quite elevated” slack in the economy would damp prices, while others saw a risk of faster inflation from the Fed’s “extraordinary” stimulus, the central bank said.
The Fed and U.S. agencies have lent, spent or guaranteed $8.2 trillion to lift the economy from the worst recession since the 1930s, based on data compiled by Bloomberg.
With economic and financial conditions now improving, the Fed needs to now review the legacy of these actions, Kliesen wrote.
The cost of living in the U.S. accelerated in November from a month earlier, led by higher prices for energy and medical care. The 0.4 percent increase in the consumer price index followed a 0.3 percent gain in October, figures from the Labor Department showed Dec. 16. The core index that excludes food and energy was unexpectedly unchanged, the first month without an increase since December 2008 and restrained by a drop in shelter costs and cheaper clothing.
Some analysts say inflation will remain low with the unemployment rate near a 26-year high, while others believe record budget deficits and large-scale asset purchase programs increase the risk of higher inflation, the report said.
Inflation was “high and variable” in the late 1980s and early 1990s, when there was “sizable disagreement” among forecasters, the report said.
In contrast, inflation was low when forecasters disagreed less during the mid-1990s to mid-2000s, Kliesen wrote. Consumer prices rose 3.7 percent on average from 1988 through 1995 and slowed to a 2.5 percent annual pace the next 10 years.
While Fed Chairman Ben Bernanke and other Fed officials are confident they are ready to prevent inflation, recent policy changes will make it much more difficult to do so, Kliesen said.
“The magnitude of the policy responses to the financial crisis and the Great Recession suggests that the FOMC’s margin of error seems much smaller than at any time in the Fed’s history,” he said.
