WHEN THE FED WISHES FOR INFLATION / THE WALL STREET JOURNAL

When the Fed Wishes for Inflation

Modest price increases but rising asset prices make the central bank’s job harder

By Justin Lahart

Shoppers flock to Herald Square in New York to look for bargains. Consumer prices rose 0.2% in February from a month earlier. Photo: Richard B. Levine/Zuma Press 


Inflation is dead, at least for now, and that is making life more difficult for the Federal Reserve.

By all rights inflation should be accelerating, driven by a tight jobs market strengthening further, a big stimulus hitting the economy and a weak dollar. But it isn’t. The Labor Department on Tuesday reported that consumer prices rose 0.2% in February from a month earlier, putting them 2.2% higher than a year ago. Prices excluding food and energy—the so-called core that better reflects inflation’s trend—rose 0.2%, leaving them up 1.8% on the year.

Friday’s strong jobs report makes the modest inflation numbers more vexing.

Inflation isn’t dead, of course. Economists point out that over the past six months core prices have risen at a 2.5% rate. Fed policy makers won’t hesitate to raise rates when they meet next week.


CORE READING
Six-month change in consumer prices,
excluding food and energy ítems, at an anual rate

But if inflation remains quiescent, and the fiscal stimulus propels asset prices higher instead, the Fed could face some tough decisions. The housing and credit bubbles that led to the financial crisis came about during a period of unexpectedly low inflation and good economic growth. The same goes for the dot-com bubble.

The Fed, and economists in general, now think asset-price excesses can cause real economic problems. But acknowledging this isn’t the same as knowing what to do. Economists still don’t agree on what makes a bubble a bubble, so it comes to a gut call. At the moment, the stock market seems pricey, but doesn’t seem like a bubble. But where would the line between the two be? And at what point would it be appropriate for the central bank to start leaning against the market, and how should it go about doing it?

If the economy and job market keep doing well, but inflation stays low, the Fed can, and probably will, raise rates four times this year. But even if it is worrying about asset prices, it could have a hard time justifying raising rates any more than that. As far as the central bank is concerned, a little more inflation might be a welcome thing.