Like it or not, history shows Ben Bernanke is right to say inflation isn't knocking at the door.
Bernanke, the widely criticized chairman of the Federal Reserve, shot back Sunday evening at the inflation hawks who claim quantitative easing – the Fed’s plan to buy $600 billion of Treasury debt over eight months, in hopes of boosting asset prices and nudging a sluggish economy forward – will send inflation soaring and destroy the dollar.
"We've been very, very clear that we will not allow inflation to rise above 2% or less," Bernanke said. "We could raise interest rates in 15 minutes if we have to.”
But Bernanke knows his 15 minutes of inflation-fighting fame aren’t coming any time soon. As long as one American in six is jobless or underemployed, there’s no reason to expect inflation to lift off, no matter what the Fed does.
And don’t just take his word for it. Economists at Goldman Sachs last week noted that since 1950, inflation has never risen during any two-year period that started with unemployment above 8%.
It is, admittedly, a small sample, with only three periods registering above 8% on the jobless scale since World War II: 1975, 1981-1984 and 2009-10. But in each case inflation fell during the subsequent two years by between 1 and 2 percentage points (see chart, right) -- even during the 1970s, now recalled unfondly as a bubbling cauldron of inflation.
The current cycle fits quite well in the falling-inflation framework. Inflation has fallen basically straight down since the so-called super spike of 2008, which saw the price of oil surge briefly to $147 in the summer before the financial system collapsed in the fall.
It was in response to this trend, as much as anything else, that Fed officials this fall started talking about the need to maintain price stability – in this case, by trying to boost inflation.
Bernanke and other Fed officials have stressed that they will revisit their quantitative easing plans whenever new data arrive, giving rise to talk that the central bank may cut short its QE plans next spring. With the economy showing signs of life and the Bernanke backlash surprising many observers, even some who see a strong case for additional QE have been trimming their expectations for the size of the Fed’s purchases.
But let's face it, that's mostly wishful thinking. For all the modest gains in manufacturing output and the heartier-than-expected appetites of consumers -- and for all the understandable fear that there will be an inflationary period years down the road -- there is no sign the jobs bust will abate in the foreseeable future.
The unemployment rate was last below 8% in January 2009, at 7.7%, and economists don’t expect it to drop below 8% again till 2013, according to the latest survey of 43 forecasters conducted by the Federal Reserve Bank of Philadelphia.
That explains why the Fed continues to fret over deflation, a spiral of falling wages and prices that makes heavy debt loads more burdensome by raising real interest rates.
"We're getting awfully close to the range where prices would actually start falling," Bernanke said Sunday on 60 Minutes. “But if the Fed did not act, then given how much inflation has come down since the beginning of the recession, I think it would be a more serious concern."
What’s more, the length of the current spell of high unemployment is on track to set an unhappy record. The unemployment rate was 8% or above for 12 months in the 1975 recession and at that level for 27 months between 1981 and 1984.
We are currently at 22 months. Try finding someone who doubts we set the record next May.
You won’t find that someone at Goldman, where economist Ed McKelvey writes in the firm’s US Economics Analyst that core inflation – excluding food and energy prices – should rise at a minuscule 0.5% annual rate through 2012.
“Although we expect growth to rise materially above its potential rate over the next two years," he writes, “the U.S. economy will still be operating with considerable slack throughout the period.” Not that anyone will cut Bernanke any, surely.