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Economic Forecasts

Prolonged Inflation Not in the Cards

Michael Dueker, chief economist of Russell Investments, believes the Fed can rein in the money supply before inflation has a chance to take off.

By Michael Dueker

Too much money chasing too few goods is the classic recipe for inflation. And one ingredient is already present -- the roughly $2.2 trillion in stimulus money that the Federal Reserve has pumped into the economy. Other sources of concern include emerging inflation in East Asia, booming commodity prices and the U.S. government's precarious fiscal situation. But the near-term risk of a long, damaging spell of inflation in the U.S. remains low.

To start, the Fed’s balance sheet is unlikely to remain extremely large. When the U.S. economy strengthens, the Fed will quickly rein in the extra cash to dampen the threat of inflation.

And inflation in East Asian countries, such as China, South Korea and Indonesia, will not spread to the U.S. because inflation in that part of the world has been triggered by government-imposed currency rigidity. A booming economy typically leads to a strengthening of a country’s currency, but governments in East Asia have intervened to keep their currencies fixed. Prices at the local level have risen as a result, but that should have little effect on inflation in the U.S.

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Another source of inflation concern is a dramatic rise in commodity prices. Yet the oil shocks of the 1970s taught us that the effect of surging commodity prices on inflation is short-lived unless poor monetary policies compound the problem. Unlike the U.S., Germany and Japan experienced only short bouts of inflation during the 1970s because their central banks did not increase the growth rate of those nations’ money supplies.

The large U.S. budget deficit may seem to be another inflationary red flag. The thinking is that the U.S. could dig such a large hole for itself that it would be cut off from the private debt markets. In this scenario, the U.S. would need to print money to repay its debts and would then suffer the inflationary consequences. But the U.S. is neither Greece, Portugal nor Ireland, where incomes can’t keep up with national debt burdens.

The recent natural disaster in Japan and upheaval in the Middle East and North Africa are more likely to push U.S. inflation lower on balance. However, the situations in these regions -- and their impact on supply, demand and the other inflation fundamentals -- are still developing. All things considered, the U.S. economy remains solid, and inflation will likely not develop into a major problem here in the next few years.

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Michael Dueker is the chief economist of Russell Investments and a former research economist at the Federal Reserve Bank of St. Louis.

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