US inflation: To ease, or not to ease? The core US consumer price index hit an annual rate of 0.8 per cent in September, its lowest level in 50 years. With commodity markets soaring and inflation still present in producer and import prices, it looks as if labor conditions are suppressing consumer prices. The economy needs rebalancing, not more money-printing by the Federal Reserve.
The headline CPI rose a little faster, 1.1 per cent over 12 months, but is still running considerably lower than the roughly 4 per cent increase in producer and import prices in the same period. The difference may be due to declining labor costs, which make up a larger slice of CPI. With productivity up 3.7 per cent in the year to June 2010, the most recent data available, unit labor costs were down 2.8 per cent. High domestic unemployment, and perhaps competition from cheaper overseas labor markets, appear to be forcing down US labor costs, thereby suppressing inflation. Ben Bernanke, the Fed chairman, suggested in a Boston speech on Friday that inflation is “too low” and that there is a case for further action to help the economy grow, probably in the form of more quantitative easing - the buying of long-term securities by the Fed.
But with wholesale inflation running at 4 percent and global commodity prices rising rapidly, inflation under the surface isn’t so benign. Moreover, there seems little chance that job creation - the Fed’s other official goal alongside keeping inflation in check - would be helped much by yet more money-printing. More likely, that would reduce the US savings rate and worsen the balance of payments deficit, with easy credit sucking in additional imports and further stoking global commodity markets.
Rather, making America more competitive requires a bigger differential between the costs of credit in the United States and elsewhere, re-establishing the advantage of comparatively cheap capital to offset the nation’s relatively high labor costs. That means higher interest rates and smaller budget deficits, neither of which would be produced by more QE. This is the rub. Bernanke seems inclined to ease, but the realities should give him pause.