How Long Can the Fed Continue to Downplay Inflation?

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When a Federal Reserve committee meets Tuesday to consider the federal interest rate, it will likely revise its glum outlook into something brighter. But will it also acknowledge inflation?When the Federal Reserve's interest-rate-setting committee meets on Tuesday to consider whether to change its monetary policy, it will likely be forced to alter the way it views the economy. It will probably rewrite its dismal assessment of unemployment, which has fallen, and acknowledge that the economy seems to be picking up. But will it also admit that the whiff of inflation is much stronger?

Prices for food and gasoline have lept in recent months, but they are not part of the key measure known as "core inflation," so the Fed tends to play down their impact. In his recent Congressional testimony, Fed Chairman Ben Bernanke said "the recent rise in commodity prices will lead to, at most, a temporary and relatively modest increase in U.S. consumer price inflation."

Tell that to Bill Dudley, president of the New York Federal Reserve Bank, who was lambasted by a crowd in New York last week and angrily asked when he's last gone shopping.

Inflation Expectations Surge

In fact, the University of Michigan consumer confidence survey released on Friday shocked many economists. It said one-year inflation expectations had surged form 3.4% at the end of February to 4.6% in March.
"Bernanke has been saying inflation expectations are still falling, but they are absolutely not," says Rob Carnell, chief international economist at ING bank. "It is just not appropriate to have a super accommodative monetary policy when the economy is growing and inflation numbers are moving up."

There's no doubt that the economy is growing stronger, as reflected by the latest retails-sales report on Friday. Retail spending grew 1% in February, with auto sales -- which increased 2.3% -- providing the biggest boost, increasing 2.3% in the month.

Unemployment has declined to 8.9%, representing a drop of a full percent in only three months. The employment component of the ISM manufacturing index in February reached its highest level since 1973.

A Less Pessimistic Outlook

As a result of these improvements, the Fed is going to have to revise the glum outlook it gave at its last meeting in January, according to Troy Davig, senior U.S. economist for Barclays Capital.

"It's getting to the point where they are going to have to start changing their assessment and acknowledge some firming in consumer spending," Davig says. He added that the employment picture also has been improving rapidly, with the so-called diffusion index showing that companies are hiring more workers than they are laying off.

Both Davig and Carnell say they don't expect the Fed to change its existing zero-percent-interest-rate policy or to step back from its economic-stimulus program of buying $600 billion of Treasury bonds -- even though it adopted that policy when things looked much glummer.
The U.S. policy contrasts sharply with Europe's, which has warned it may start raising interest rates next month to stave off its inflation problem. The news has caused a huge realignment in currency rates, with the euro surging and the dollar falling.

Should the Fed End QE2?

Carnell claims the U.S. bond-buying program, known as quantitative easing, is doing as much harm as good and should end before its scheduled stop in June. "It's an irrelevant policy that's causing all sorts of distortions," he says, noting that it has caused a huge bout of inflation in places such as Brazil and China as investor funds leave the U.S. in search of higher returns.
But, reading between the lines, the Fed seems determined to continue with quantitative easing for the next few months, despite the economy's pickup, Davig says.

What remains unclear is what Bernanke plans to do with another program, announced last August, that calls for the Fed to use the interest it makes from the bonds it owns to buy new Treasuries, further stimulating the economy.

"What's going to happen to the reinvestment is less clear," Davig says, "A natural thing to do is freeze it."

At least if Bernanke rewrites his outlook, American consumers and companies will have a better fix on where things stand. That will help them make better spending decisions in the next few months.

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178 Comments

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swils16431

What does it take to show inflaction? Last year (2010) my average grocery cost was $125.00 per week. Only 10 weeks into2011 I am at $155.00. No inflation!!!

March 16 2011 at 4:46 PM Report abuse +1 rate up rate down Reply
swils16431

What does it take to show inflaction? Last year (2010) my average grocery cost was $125.00 per week. Only 10 weeks into2011 I am at $155.00. No inflation!!!

March 16 2011 at 4:45 PM Report abuse +2 rate up rate down Reply
rcohn95038

These Elite Economists, who probably have not set foot in a supermarket in ages, will likely keep lying to us, and claim, that all is under control. Perhaps they could bring themselves to talk to a normal person once, so they might learn that there is rampant inflation in the real world. They should stop there fatal policies, of easy money, and face the music. Also, to the writer of this article; the economy is not improving, unless you believe, that, when people stop looking for work, and drop out of the economy, that means the economy is getting better.
Do you live in LALA Land?

March 16 2011 at 4:28 PM Report abuse +2 rate up rate down Reply
jkennedy806

i'LL GIVE IT 72 HOURS

March 16 2011 at 4:09 PM Report abuse rate up rate down Reply
cpmadden

The inflation figures are insanely misleading. Since the do not include the cost of gas and food, it is meaningless! What is it that we need/use more of than anything else?? Duh...gas and food! The unemployment figures likewise are wrong, it only 'went down' because of the large number who gave up looking....and if you're not actively looking...you're not counted. Its strictly for political effect....not tied to REALITY!!!

March 16 2011 at 3:40 PM Report abuse +2 rate up rate down Reply
thedtecter

The FED and Washington DC will continue to get away with it until the media starts holding both accountable

March 16 2011 at 2:26 PM Report abuse +3 rate up rate down Reply
GARY

LYING bunch in WASHINGTON. THEY DON'T COUNT WHAT AFFECTS the TAX PAYER THE MOST, FOOD and FUEL!!! WHAT A CROCK OF B/S!!!

March 16 2011 at 2:04 PM Report abuse +2 rate up rate down Reply
elkhartbiker

The steady rise in gold and silver prices ought to give the Fed a clue that Americans aren't stupid. They know that you can't continue to print money and not end up with run-away inflation. Some things about Econ 101 never change.

March 16 2011 at 10:36 AM Report abuse +3 rate up rate down Reply
rbonvie

Hello Washington, Mr. Bernanke main street is not LENDING, please pass on to our president. thank you

March 15 2011 at 7:49 PM Report abuse +7 rate up rate down Reply
wwas3434

bankofamericasuck.com has a great cartoon about the Federal Reserve how it was started and why Thomas Jefferson and our founding fathers hate banks especially the Federal reserve. How many readers are aware the FED is a private bank and it only prospers wall street and the rich. I like Jefferson and Kennedy say it is time to get rid of the parasites

March 15 2011 at 3:03 PM Report abuse +5 rate up rate down Reply