Is Inflation Making a Comeback?

The Federal Reserve isn't likely to repeat past mistakes.

Gas is going for more than $4 a gallon, gold is riding a boom, and the Federal Reserve is seemingly complacent about these developments. Among critics of Barack Obama and Ben Bernanke, the consensus is clear: Inflation is making a comeback.

"The Bernanke policy of printing money is setting the stage for massive inflation," claims former House Speaker Newt Gingrich. Rep. Ron Paul (R-Tex.), decries "the inflation all Americans suffer due to the Fed's relentless monetary expansion." Former Sen. Rick Santorum (R-Pa.), fears not just inflation but "potentially hyperinflation."

The claim has a surface plausibility. If the money supply is growing and prices are rising, what more evidence do we need? But first impressions, in this case, are badly misleading.

Take the price of gold. It has more than doubled since Obama was elected in November 2008, allegedly because investors want a hedge against an increasingly worthless currency.

But gold prices were also on a rocket during the previous eight years. And they were not a portent of raging inflation. During the administration of President George W. Bush, the consumer price index (CPI) rose at an average rate of less than 3 percent per year—while gold was tripling in value.

Oil and other commodities, believe it or not, can be affected by events that don't occur in the United States. Bentley University economist Scott Sumner, who sees no chance of an inflation outbreak, attributes rising prices for oil and other goods to strong demand in developing countries, particularly China.

Though some U.S. prices have jumped recently, most have not. The "core" inflation rate, which includes everything except food and energy, was 1.2 percent over the past year.

That may seem painfully irrelevant, given the supreme importance of groceries and gas. But you can't have general inflation without core inflation. If the Fed is flooding the economy with excess money, sooner or later all boats will rise.

Over the past decade, core inflation provided a pretty good gauge of overall inflation. The core CPI rose by 21 percent. The full CPI rose by 27 percent.

Comparisons with the last serious bout of inflation, the 1970s, suggest that today's worries are misplaced. Back then, it wasn't just fuel and food that soared: The cost of everything soared.

The depreciation of the dollar, likewise, is not really the unspeakable horror often portrayed. No one seems to recall that the greenback fell against the euro for most of the past decade.

That long-term decline, it turned out, was not a sign that you would soon need a wheelbarrow to carry your bus fare. Inflation remained firmly under control despite the worsening exchange rate.

There is no indication that inflation is heating up this time, either. Investors wouldn't be snapping up three-year Treasury notes at 1 percent if they were expecting their purchasing power to be ravaged by wolves at any moment.

It's true that if the Fed pumps too many dollars into the financial system, it will eventually mean too much money chasing too few goods, pushing prices through the roof. But in the aftermath of the near-death experience of 2008, banks have been happy to hang on to cash rather than lend it out. By a broad measure known as M2, the money supply has been growing very slowly.

What Bernanke has done to ward off a catastrophic collapse is not at odds with keeping inflation down. In fact, a decade ago it was recommended to the Japanese central bank by Nobel laureate economist Milton Friedman, who was famed for his aversion to inflation.

The spike in commodity prices has raised fears of a 70s-like wage-price spiral: Prices climb, so workers demand pay raises, which causes their employers to raise prices again, which sparks another round of wage increases.

But you can't have a ham sandwich without ham, and you can't have a wage-price spiral when unemployment is high, workers have little bargaining power, and pay is stagnant. Wages and salaries, according to the Bureau of Labor Statistics, are up only 0.4 percent in the past year. Raise your hand if your pay is spiraling—upward, I mean.

The last epidemic of inflation, in the 1970s and early '80s, was a searing experience, from which the Federal Reserve learned lessons it has no desire to repeat. Is inflation coming back? Sure. Right after the Ford Pinto.

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