Magazine article The International Economy

Could America Soon Have an Inflation Problem?

Magazine article The International Economy

Could America Soon Have an Inflation Problem?

Article excerpt

Economist Marty Feldstein argues that because short-term unemployment is so low, the result could be that "inflation could soon begin to rise year after year without any further decline in overall unemployment." Others argue that inflation will accelerate for a different reason: because of the increased size of the monetary base. Other economists, including Brad DeLong, argue that the inflation worry is vastly overblown.

Is the United States flirting with an inflation problem? Moreover, what are the risks of policy error on the inflation issue? In the 1990s, for example, after a period of low interest rates, the Federal Reserve raised short-term rates with significant unintended consequences, including the outbreak of the Asian crisis and the Russian default. Today the risk would be the unwinding of the global carry trade and dangerous loss of liquidity throughout emerging markets.

Are Fed policymakers today behind the curve on the inflation front? Or is all this talk of monetary tightening playing with fire?

ALICE RIVLIN

Senior Fellow in Economic Studies, Brookings Institution, and former Vice Chair, Federal Reserve Board

It would be really nice to have to worry about inflation again. If the economic outlook were for robust growth, tight labor markets, rising wages, even a few shortages of skilled workers, economic policymakers would feel more cheerful. The Federal Reserve could then confidently raise interest rates to what used to be considered "normal" levels.

Alas, that is not the situation policymakers are facing in 2015. The optimistic view is that the U.S. economy has enough positive momentum to keep the recovery going, push unemployment down a tad more, encourage stronger labor force participation, and nudge inflation back up to the Fed's 2 percent target. The pessimistic view is that weakness in the rest of the world and the strong dollar will cut our exports and make the momentum hard to maintain.

The longer-run outlook is not encouraging, either. Labor force growth will be slow, estimates of potential growth are being revised downward, and our gridlocked politics precludes the bold public investments that could help the economy grow more strongly. The situation in Europe, the United Kingdom, and Japan is hardly more cheerful. Inflation is not on the horizon in any major developed country. Indeed, potential deflation is higher on the list of potential threats.

Moreover, even if some unforeseen set of shocks were to accelerate price increases, there would be little risk of inflation getting quickly out of hand. The U.S. economy is much less inflation-prone than it was in the 1970s and 1980s, when central bankers felt they had to keep a wary eye on the inflationary beast lest it leap out of its cage and get away from them. Our economy is far more competitive than it was in those days, supply chains are more responsive, unions are a disappearing force for wage increases, multi-year wage contracts with escalator clauses are a thing of the past, and outsourcing has become the norm. Most importantly, inflationary expectations have gone dormant and are unlikely to revive quickly. The robust growth and tight labor markets of the late

1990s did not produce worrisome inflation. The following decade's run-up to the financial crisis produced a housing price bubble without general inflation. A whole generation has grown up reading about some vague thing called inflation without experiencing it. They are not likely to take the self-protective actions that used turn a little inflation into a serious threat.

So let's cross inflation off our list of worries and get back to the real world of the twenty-first century. We need to figure out how to grow the economy faster and share the prosperity more widely. If we are really successful, we might earn the luxury of worrying about inflation once again.

MARTIN FELDSTEIN

George F. …

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