Janet Yellen to wrestle with ideal inflation amount

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Posted: Tuesday, November 19, 2013 12:00 am

WASHINGTON — Somewhere between Venezuela and Japan is exactly the right spot when it comes to inflation. Getting the United States there could be a key challenge for Janet Yellen.

The country’s central bank right now wants a little more inflation than the current rate of 1.2 percent, lest it sink backward into the kind of deflation that can sap an economy as it has in Japan.

At the same time, some economists worry that the Fed’s stimulus of the economy now will have an inflation hangover later, driving an excessive rate of jumping prices such as those that wrack Venezuela today.

Yellen, nominated to be the new chairman of the Federal Reserve, will wrestle with the right approach if confirmed by the Senate.

The tension between the Fed sparking some inflation and the risk of losing control of it spilled into the Senate Banking Committee last week as it opened hearings into Yellen’s nomination. Inflation, she said Thursday, “has been running below the Federal Reserve’s goal of 2 percent and is expected to continue to do so for some time.”

All but forgotten for most Americans, inflation erodes spending power, especially for retirees on a fixed income.

Once in the double digits a generation ago, the inflation rate has been below the Fed’s target rate of 2 percent for much the economic recovery that began in June 2009. It’s gone from 2.2 percent in October 2012 to 1.2 percent this September.

“I see the inflation risk as a remote one and the deflation risk as potentially greater,” said John Makin, a resident scholar at the American Enterprise Institute.

With rising inflation, consumers and businesses buy on fear that prices will rise further. This is happening today in Venezuela, where an unofficial inflation rate of 50 percent has crowds rushing to buy television sets before prices jump. This surge in demand makes products scarce and thus even more expensive.

Deflation, experienced by Japan over the past decade, is when consumers and businesses sit on the sidelines in a collective bet that they’ll get a better price later. Retailers must cut prices on those television sets or even sell them at a loss.

Combating deflation by creating inflation is implicit in the Fed’s controversial monthly purchase of government and mortgage bonds. Since December 2012, the Fed has been buying every month $85 billion of these bonds with the express intent to drive down the cost of long-term loans.

It’s made it easier to buy a car and cheaper to buy a house. It’s raised the price of stocks, boosting fortunes on Wall Street and the investment and retirement savings of ordinary Americans alike. All that activity has helped spur some inflation by fostering more economic activity and making people feel wealthier and willing to spend.

In the process, the Fed’s effectively created money to purchase government and mortgage bonds, pushing its holdings to $3.8 trillion.

Historically, when a government prints more money, it reduces the value of that money. That causes prices to rise — inflation — because producers need to get more for their product, since what they’re earning now buys less. And it becomes a vicious circle.

“If you keep pumping money into the economy, and that money starts to find its way into (sales) ... it’s in the pipeline,” said Martin Regalia, chief economist for the U.S. Chamber of Commerce. “If it does start to increase the money supply . . . it absolutely will create inflation.”

Supporters of the Fed policy scoff at the idea of looming excess inflation.

“I don’t think there is any sign of inflation just over the horizon,” said Donald Kohn, who preceded Yellen as the Fed vice chairman. “Some people wonder how long it will take to get the inflation rate up to the 2 percent target rather than over it.”

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