How are the Feds Coping with Inflationary Pressures?
The short answer is on how inflation is measured and what components of the economy are used. The Feds rely on the Consumer Price Index (basket of goods and services CPI) and its components are used to fine-tune other economic series for price changes and interpretation of these indicators into inflation-free dollars. The resulting blend of indicators renders the purchasing power of a consumer's dollar measured against the exchange in value of goods and services that a given dollar will buy at a given calendar time.
Episodes of high inflation can often be attributed to lax monetary policy. If the money supply grows too big relative to the size of an economy, the unit value of the currency diminishes. There is agreement among many economists about the proportionality distribution between excess currency circulation and prices. This relationship between money supply and the size of the economy is known as the quantity theory of money, and is one of the oldest hypotheses in economics.
Central banks use a target inflation rate to modulate economic growth, money supply and consumption but if inflation gets out of hand it could mean that the target inflation is not under control or that the commitment to a target is not strong enough for political reasons.
The world in general and in the US in particular, have enjoyed low inflation and abundance of goods to choose from for an extended period of time which, can be explained by a combination of sound economic policies and technological change. Technology has also increased productivity, thereby reducing the costs of inputs to a unit of production. Most economies have now flattened productivity gains, nonetheless, inflation is still low?
Analysts are studying and trying to explain a new wave of productivity based on a “shared economy” mainly, based on the effects of international trade and the expansion of other means of production. Some of this added productivity is coming from resources that used to be idle but are now participating in economic growth. A good example of the share economic expansion is Uber’s-- car sharing and Airbnb's--home sharing economic models.
Additionally, as the world’s population gets older, another component of change must be included with its impact on changing demographics and how it can exert inflationary pressure in the short and long run. Finally, the effect of globalization is changing traditional economic statistical metrics to include new methods to asses its effects on share economies.
The extended period of low inflation and interest rates is nearing its end as the accumulated effects of the economic variables suggest that expectations in the financial and commodity markets will translate to changes in price levels in the larger economy.
The shift is mostly driven by an increase in investors’ expectations for future inflation. In the United States, prices of inflation-protected bonds imply that investors currently expect consumer prices to rise and the Trump administration policies may be playing a role.
Largess in tax cuts and increased spending will result in hundreds of billions of dollars more in Treasury bonds being issued in the coming years which mean the government will have to pay higher interest rates to find buyers of that debt. As a result, the Feds are facing economic realities unrelated to politics and must apply the traditional equation of [New Debt-Maturing Debt = Primary Deficit + Interest Payments]. In other words, the government must issue new debt to cover the primary deficit which is-- the difference between non-interest spending and revenues—the principal on debt, and interest payments on past debt.
This economic reality is inescapable no matter how Trump massages his economic policies and his rosy scenario messaging to the public.
