TOO LITTLE INFLATION ? / THE WALL STREE JOURNAL REVIEW & OUTLOOK ( RECOMMENDED READING )

REVIEW & OUTLOOK

SEPTEMBER 23, 2010.

Too Little Inflation?

Central bankers who say they want higher prices usually get them..

Critics have long been urging the Federal Reserve to adopt a formal price rule to guide its monetary decisions, and this week the Fed finally came up with one, sort of. Lesson: Be careful what you wish for.

In its statement after its Tuesday meeting, the Fed's Open Market Committee couldn't have been clearer that it wants more inflation. "Measures of underlying inflation are currently at levels somewhat below those the committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability," the statement said.

Not so long ago, the Fed was fretting about the risks of deflation, which is a declining price level and is something to be avoided. Several Fed governors had hoped to use the deflation argument as a justification to resume more active asset purchases, or "quantitative easing." But deflation is hard to detect in an economy in which commodity prices are rising, gold is close to $1,300 an ounce, and credit market spreads have been healing.

Enter the Fed's words "maximum employment," which offers a new justification for more potential easing, perhaps after the election in November. And by calling the inflation rate too low, the Fed is signaling that it wants more inflation in order to reduce unemployment. No wonder gold kept rising yesterday, and the dollar kept falling, as investors interpreted the Fed decision as a promise to continue its Great Reflation until the jobless rate falls.

This may win the Fed some plaudits on Wall Street and deflect some criticism in Congress, but it won't fix what is ailing this economy. Monetary policy can't compensate for Washington's current mix of bad fiscal, tax and regulatory policies. Meanwhile, further asset purchases would plunge the Fed even further into credit allocation, making it that much harder and taking it that much longer to return to a normal, much less politicized, monetary policy. Central bankers who wish for more inflation usually get their wish, and the result is rarely benign.

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