QE3 a Recipe for Inflation

By Logan Albright

Last week Federal Reserve officials announced that they may be willing to implement a third round of quantitative easing in hopes to boost the struggling U.S. economy. This comes just one day after a report that consumer borrowing increased dramatically in the month of November, indicating a growing level of confidence in the economy.

It is hard to reconcile these two reports, as one shows signs of optimism while the other paints a somewhat more dire picture. The Fed has already slashed interest rates to record lows, and they have remained stuck at close to zero for more than three years. Additionally, the Fed has pumped more than two trillion dollars into the economy in an effort to stimulate spending.

There is a well established phenomenon within the field of economics known as the Phillips Curve. Simply, it depicts the short run trade-off between inflation and unemployment; in order to reduce one, we must tolerate a rise in the other. December’s unemployment numbers, combined with the report on consumer borrowing are early indicators that we should prepare for steeply rising inflation in the near future.

Indeed, it has already begun. According to figures published by the Bureau of Labor Statistics, the inflation rate for November was 3.39%. That may not sound like a huge number, but it is nearly three times as high as it was a year earlier. It is also important to remember that these figures were calculated using the Consumer Price Index (CPI), a measure which most likely understates the true level of inflation.

The CPI is calculated as a weighted average of the prices of various consumer goods. This can include everything from electronics to food to apparel to housing, and depressed prices in certain markets (housing) can mask inflated prices in others (food.) This would not be such a big problem were it not for the fact that the dramatic fall in housing prices has had nothing to do with the value of our currency per se, but whereas the rise in food prices is likely due to exactly that.

A more realistic picture of what is happening to our currency can be gleaned by looking at the foreign exchange markets, where the dollar has been steadily slipping against prominent Asian currencies such as the Yen and the Yuan. The market for gold and other precious metals is also telling, with these commodities rapidly gaining value against the dollar.

Several high ranking Federal Reserve officials say that they expect the dollar to slow its loss in value next year, but it is unrealistic to think that an economy can be flooded with two trillion dollars of freshly minted currency and not show signs of inflation. Thus far, the damage has not been overly great due to the cautious thriftiness of the American consumer, but with signs that confidence may be returning, a third monetary stimulus would be an invitation to runaway inflation. Interest rates have been too low for too long as it is, and if the Fed does not allow them to rise soon, we may all find ourselves longing for the halcyon days of four dollar a gallon gas.


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