The Markets

Exceptional… exceeds expectations… meets expectations… needs improvement… unsatisfactory. It’s a rating system familiar to anyone who has ever received a performance review. Right now, the performance of inflation is not meeting expectations – and that may be a good thing. 

Critics of loose monetary policy and rock bottom interest rates have had high expectations for inflation. That is, they have predicted inflation will rise. In March 2012, Martin Feldstein, a professor of economics at Harvard and President of the National Bureau for Economic Research, explained the massive liquidity created in the United States by the Federal Reserve’s easy money policies created a risk of rising inflation. A rapid increase in bank credit would boost the money supply and the rate of inflation unless the Fed raised interest rates in a timely way and on an adequate scale. 

So far, low interest rates and unusually aggressive monetary policies haven’t led to higher inflation in the United States or other at-risk regions. The Conference Board’s Harmonised Index of Consumer Prices (HICP), an inflation measure, showed prices in the United States increased by 0.8 percent in September 2013. That’s slower than the 2.1 percent increase reported for 2012.

In the Eurozone, the inflation rate for October fell to 0.7 percent, which was the lowest in almost four years. A recent article in The Economist explained it like this: 

“So, why haven’t we had the inflation that some predicted in the wake of quantitative easing? The reason is that central banks are not the only, nor indeed the main, money creators. Money is usually created by the private banking system and that has been trying to shrink. If the money supply is a bath, then the central banks may have turned on the taps, but the commercial banks have pulled out the plug.” 

That may mean, despite stable and falling inflation rates in some regions, we’re not out of the woods yet. As Mr. Feldstein wrote last March, commercial banks could begin to lend funds to firms and households. If that happens, “Loans could add to deposits and cause the money supply to grow. They would also increase spending by the borrowers, adding directly to inflationary pressure.”

 
 
 

Lexington Wealth Management