— by Inya Ivkovic, MA
With inflation remaining silent in July and likely to remain that way for months to come, the Fed still has plenty of wiggle room, which is needed to boost the economy by keeping interest rates at ultra-low levels. One more reason not to worry about inflation came from wholesale prices, which plunged 0.9% in July, three times more than economists forecasted and the most ever since the Labor Department started keeping track of them in 1947. In other words, pricing power seems to be literally nonexistent in the current economic environment.
Driving the price decline were energy and food prices, which are inherently volatile, but even excluding them, inflation was more than tame. Two days ago, the Consumer Price Index figures were released, indicating that inflation has dropped 2.1% in the past 12 months. Additionally, what remains after energy and food prices are excluded is “core inflation,” which dropped 0.1% in July and which clocked in a moderate “senior’s” rate of 1.5% in the past 12 months, well within the Fed’s comfort zone. And if this tame inflationary rate persists, which is more than likely considering the havoc that high unemployment, wary consumers and tight credit have wreaked on prices, the economy stands a decent chance of launching a sustained recovery, albeit a prolonged one, in an ultra-low-interest-rate environment.
So, if we should not worry about inflation in the short term, should we worry about it in the long term? I’d say what will drive inflation higher in the medium term, although not into the stratosphere, will be the recovery itself, which, as it takes hold, will entice retailers to drop the insane promotions they are using now to attract shoppers back to their stores and dealerships. But, in the long term, things may not be so rosy, as the economy goes through the deleveraging process and as governments around the world unload all the debt off their balance sheets.
When can we expect interest rates to start rising? Given forecasts that this recovery is going to be slow and often interrupted, risks of serious inflation for at least a year are low. This means that, if and when the Fed starts increasing interest rates, it will be gradual and in small, steady increments.
What is going to delay the recovery? In no uncertain terms, it will be the unemployment rate, which currently sits at 9.4% and which is not likely to peak until at least next summer, somewhere in the low 10% territory. Why such slow recovery in the labor market? As long as the unemployment is rising, workers have little to no bargaining power over wage increases. As long as people deal with the ever-shrinking disposable income, there is no hope of consumer spending getting in gear anytime soon. And as long as consumers are keeping a low profile, we cannot even begin talking about a sustainable recovery.