Fed Chairman Ben BernankeIf any investors think the massive fiscal and monetary stimulus has triggered inflation in the U.S., they should study the September consumer price report, which indicated that consumer prices rose just 0.1% -- less than expected. And the core rate -- which excludes the often-volatile food and energy component -- was unchanged.

A Bloomberg survey had expected September's consumer prices to rise 0.2% and the core rate to tick 0.1% higher, after an 0.3% overall rise in August (when the core rate lifted by a scant 0.1%). July's CPI rose 0.3%, after falling 0.1% and 0.2% in June and May, respectively.

However, the current flatness in prices isn't what the U.S. Federal Reserve -- the public institution most responsible for price stability -- wants to see. It actually would prefer a little more inflation in the economy.

Plenty of Work to Do

The reason? Deflation, a protracted, systematic decline in prices, robs companies of revenue and can lead to the dreaded "deflationary spiral," in which price cuts lead to lower corporate revenue, prompting more layoffs and further consumer spending declines, which prompt more price cuts, and so on. Deflation took hold hold during the Great Depression of the 1930s and made it worse. That's something Depression scholar and Fed Chairman Ben Bernanke knows all too well.

Judging from September's report, the Fed has some work to do in order to prevent deflation from taking hold.

Top-line inflation over the past 12 months is running at a low 1.1% rate, and the core rate is a minuscule 0.8% -- the lowest year-over-year core rate since 1961 and down from the 0.9% registered in August. That 12-month core rate is about as low as the U.S. Federal Reserve wants on a full-year basis. Further declines would probably signal that deflation has started.

"Unwelcome"

Bernanke underscored as much during a speech today to the Federal Reserve Bank of Boston on monetary policy in a low-inflation environment. "Further disinflation would be unwelcome," Bernanke said, adding that an inflation rate greater than zero would be the Fed's goal.

"Committee participants have generally judged that a modestly positive inflation rate over the longer run is most consistent with the [Fed's] dual mandate [of price stability and full employment]," Bernanke said. "The view that policy should aim for an inflation rate modestly above zero is shared by virtually all central banks around the world."

September's CPI report clearly shows that overall inflation isn't going where the Fed wants. The price increases were concentrated in the food and energy component -- volatile components that are often affected by seasonal and foreign factors, not by organic domestic demand. In September, energy prices surged 1.8%, with gasoline prices jumping 1.6% and fuel oil rising 0.8%. Food price rose 0.3%.

Elsewhere, the price increases were largely modest, and there were actual price decreases. Medical care services jumped 0.8%, new car prices rose just 0.1% and shelter costs were unchanged. But commodities fell 0.2%, clothing prices plunged 0.6%, used-car/truck prices sank 0.7%, electricity prices declined 0.3%, recreation costs decreased 0.3% and education costs fell 0.1%.

Bernanke's speech suggests that the Fed -- at minimum -- is likely to maintain its "extended period" of low interest rates through winter. It'll likely also again buy a range of assets to further stimulate the economy -- the second stage of the Fed's quantitative easing policy, or QE2. Deflation is the dragon that's slowly stirring, and the Fed wants to slay it before it takes wing.

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