DEFLATION SCARE: The Newest Reason For QE?

Cartoon by Jordan Roy-Byrne, CMT

Photo: Jordan Roy-Byrne, CMT

The illustrious Wall Street Journal Federal Reserve Reporter Jon Hilsenrath is back again, this time highlighting that under-target price indices could drive the Fed to take stronger monetary policy action.This despite the fact that the latest measure of GDP came in slightly higher than economists expected, relieving some fears that the economy has slowed dramatically.

The Fed watches core PCE rather than CPI. The latter is an inflation indicator that most analysts use interchangeably with inflation, and which came in at 1.7 per cent for June.

Both CPI and PCE price indices have missed the Federal Reserve’s target for adequate inflation in the economy. Hilsenrath writes:

Key price indexes are uniformly running below the Federal Reserve‘s 2% objective. The personal consumption expenditures price index was up 1.6% from a year ago, thanks in part to falling gasoline prices. This is the price index that the Fed watches most closely, more so than the consumer price index produced by the labour Department, which is running a touch higher. Excluding food and energy, the PCE price index was up 1.8% from a year ago. The Fed watches this ex-food-and-energy index to get a read on underlying inflation trends. For the quarter at an annual rate, the PCE price index ran at 0.7% and excluding food and energy it ran at 1.8%. An alternate measure, the “market-based” price index, is also running below 2%. This is ammunition for Fed officials who want to act right away to spur growth. Not only is growth subpar, and the job market stuck in the mud, inflation is also running below the Fed’s long-run goals.

It’s worth noting that the Fed always takes into account price stability in their monetary policy decisions, however economists have generally pointed to their outlook on unemployment as a primary driver for QE. The argument here is essentially that the economic data might not have to be that bad if the Fed becomes seriously concerned about deflation risk.

The big question now is whether Bernanke and company will address these risks immediately. Another Hilsenrath article that ran earlier this week indicated that the Fed did see downside risks to the economy increasing. However, he noted that there were numerous reasons it might wait until September to make big changes in policy.

Read his full take on today’s GDP release at WSJ >

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