Gasoline pricesWall Street's penchant for overreaction aside, it's understandable why many investors might be bracing for scorching inflation ahead. Already posting a stronger rebound than many commentators had expected, the U.S. economy shows signs of picking up yet more steam. Some high-profile economists are expecting growth rates as high as 6% in the year ahead, and bellwether companies like Caterpillar (CAT) continue to report strong global demand.

That by itself is often enough to result into inflationary pressure. But lately, fears of a conflagration in prices have been exacerbated by the vast easing measures the Fed continues to take in response to the financial crisis.

The reasons to count on major inflation under these circumstances seem straightforward enough. But much like the actual impact of spiking commodity prices, the way inflation plays out is far more complicated. And while the usual pressures get plenty of press, countervailing forces can be far easier to overlook.

Restarting Idled Resources

While U.S. GDP may be ready to deliver impressive gains, measures like industrial production, which took a major hit during the recession, still have a ways to go. Indeed, industrial production remains 6% below its pre-recession peak, analysts at TD Economics wrote in a research note this week, and it will take another year to close the gap even at the present three-month average growth rate.

"Throughout the post-recession expansion, growth in [industrial production] has stemmed not from the generation of new productive capacity, but from increased utilization of existing resources that had lain idle during the downturn," analysts at TD Economics wrote in a research note.

That means plenty of spare capacity can still be brought on-line, and that should help dampen inflationary forces. "With industry operating below potential, we believe inflation will stay subdued for now," the analysts wrote. "And with a fair amount of slack to absorb, the Fed will be in no rush to tighten monetary policy soon."

All that money the Fed created, meanwhile, might not lead to inflation as directly as some of Ben Bernanke's most strident critics claim. Along with the raw supply of money, the amount of that cash put into circulation -- sometimes called the velocity of money -- plays an equally important role.

Dormant Cash Isn't So Dangerous

And that leads to a much more complicated relationship to inflation than the constant howling about the obviously dire consequences of the Fed's money-printing would suggest.

"In order for any monetary variable to be reliable, the so-called 'velocity' of money in circulation needs to be stable, which is not often the case," Jim O'Neill, the high-profile head of Goldman Sachs Asset Management wrote in a research note. More money supply, in other words, doesn't simply translate into inflation. Cash laying dormant doesn't bid up the value of prices.

It's also natural for investors to think back to times when inflation ravaged the economy, like during the 1970s, when assessing risks. But things have changed dramatically since then, and the fact is that inflation has remained at benign levels for decades since that awful time. A combination of many fundamental shifts in the economy is often credited for this.

"Originating with the tough anti-inflationary policies of Paul Volcker at the Federal Reserve in the U.S., the widespread introduction of deregulated markets, globalization, and the introduction of the Internet have all been huge forces to bring the inflation process to where we broadly sit in current times," O'Neill wrote.

Given an economy now gaining steam and a vast expansion in the money supply, it's easy to assume inflation is up next. The causes of inflation, however, are anything but straightforward. And investors are better off keeping a close eye on incoming data than blindly believing the pundits who have a simplistic view of inflation.

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May 29 2011 at 1:12 AM Report abuse rate up rate down Reply


February 23 2011 at 1:51 PM Report abuse rate up rate down Reply

Thank goodness that President Obama has made sure we do not drill for more oil.. can't wait for gas to hit $5.00 per gal... then I can buy a over priced solar/windmill/battery driven auto, that is if I had $40,000 to buy one. Of course since IM unemployed I will have to use my unemployment funds to pay the $5.oo. sure don't know what I will do when that runs out.

February 23 2011 at 12:42 PM Report abuse +1 rate up rate down Reply

The reality is most of the things that people use on a daily basis (food, gas, Insurance) have had noticable price increases over the past year.
They can use whatever voodoo mumbo jumbo numbers/indicators they want but I live in the REAL world and see it every day. Not looking for any handouts or freebies...just want a fair shake once in a while.

February 23 2011 at 11:46 AM Report abuse rate up rate down Reply

when bush was president, here in ny, schumer was on tv, radio, in the papers everyday screaming about the oil prices. now that obama is president he is no where to be found. its disgusting. i emailed schumers office on this and needless to say have not received a response, not even an automated response, way to go chuckie.

inflation by the way is not complicated, sorry vishesh. i guess since aol bought the huffington post they have to put a liberal spin on it. maybe inflation is complicated when they thought the bailouts and stimulus's money would solve all problems instead of deepening the existing ones.

just for the record almost everything i have purchased in the last 3 months i have paid more for and have less money in the bank. to me thats not complicated; but i guess to some that have an agenda is complicated.

February 23 2011 at 10:09 AM Report abuse +3 rate up rate down Reply

Where is the President??????? Why havent we heard from him on this issue we are facing a major junction here with these prices on gas and diesel it will cause the economy to tank very quickly. This guy wanted to be President in the worse way and now no leadership... unreal this guy...

February 23 2011 at 9:28 AM Report abuse +3 rate up rate down Reply

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February 23 2011 at 8:33 AM Report abuse -1 rate up rate down Reply

Inflation has been here for months - all that printing of dollars makes the dollar worth even less. Fed's voodoo economics helps banksters on the backs of the middle class.

February 23 2011 at 8:28 AM Report abuse +1 rate up rate down Reply

If anything, this finanial mess we're in has shown people how to live for less.

Gas goes up, no one travels - that hurts for weekend trips, but most will not give up their major vac trip.

You can not buy food with gold or silver and now u can not buy the gold because it is hi.
America needed this adjustment - When i saw people making $30000/ yr buying $500000 homes, I said what the hells going on here. Well now they do not have the house or job. I got a house worth less and its all the governments fault for letting people get those homes.

February 23 2011 at 8:23 AM Report abuse +1 rate up rate down Reply