The inflation story – what is the evidence?

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This post is a guest contribution by Paul Kasriel* of The Northern Trust Company.

There is a growing concern about an inflationary threat in the U.S. economy given the enormous monetary accommodation the Fed has put in place. As expected, there are differing opinions about this issue. First, the unemployment rate in September was reported as 9.8%; the all inclusive unemployment rate is 17% (see chart 1).

nt-0910-pic1

Wages are unlikely to be the cause for a large increase in inflation in the near term because widely used measures of wages pressures are trending down (see chart 2), given the lack of demand in the labor market. By the way, the Federal Reserve tracks these variables to form its assessment of inflation.

nt-0910-pic2

Second, the operating rate of the nation’s factory sector was 66.6% in August, close to the record low mark of 65.1% registered in June 2009.

nt-0910-pic3

Third, financial institutions are not lending (see chart 4) implying that a stalled credit machine supports expectations of a non-inflationary environment in the near term.

nt-0910-pic4

What is the indication from the market based measure of inflation expectations? Inflation expectations as measured by the difference between the yield on Treasury securities and TIPS are below the pre-crisis levels (see chart 5).

nt-0910-pic5

In sum, the overwhelming evidence presented here points to a Fed worrying about inflation in the early part of the next decade. It is important to note that concern about inflation is the long term story. Paul Kasriel has published a detailed analysis of the long-term outlook for inflation (Greater Risk over the Next Five Years – Inflation or Deflation?)

Source: Northern Trust – Daily Global Commentary, October 8, 2009.

* Asha Bangalore is vice president and economist at The Northern Trust Company, Chicago. Prior to joining the bank in 1994, she was consultant to savings and loan institutions and commercial banks at Financial & Economic Strategies Corporation, Chicago.

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