Low Inflation and Further Fed Action

I want to present three quick ideas, mostly from a recent speech by SF Fed President John Williams.  Here’s the link to the speech.  It certainly seems like he’s making the case for more Fed action.

1. Inflation expectations are low.  Several Fed Presidents and Fed Governors have predicted that inflation will be below 2% for the next year.  This is significant for many reasons:

A. we could start to have fears of deflation

B. low inflation means that for a given nominal interest rate, the “real interest rate” (the rate of interest excluding inflation) is higher.  In other words, if you can get a 4% loan and the inflation rate is 3%, your real rate of interest is 1%.  If there is no inflation, the real rate is 4%.  Since the Fed is doing all it can to reduce nominal rates, they would like to see some (limited) inflation to keep the real rates lower.

C. low inflation means that the Fed believes it can do more to stimulate the economy without worrying about inflation.  Whether you agree with this or not, this is how the Fed is thinking right now.

See below for a chart on inflation from Boston Fed President Rosengren.  It shows the drop in inflation during the past six months compared to the prior six month period.

2. SF Fed President John Williams recently spoke and forecast 2.5% GDP growth for the year.  But, he said that there is one risk that would cause the economy to perform much worse – Europe.  Specifically, he said, “European leaders have been working to solve this problem and they may be able to muddle through.  But, if they fail, all bets are off.”  There’s a happy thought.

3. It sure seems like the Fed is starting to jawbone for more action.  Some comments from SF Fed President Williams about the unemployment situation include, “the unemployment rate is still shockingly high” and “the level of unemployment is a national calamity that demands our attention.”

Have a great week.

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