How Will Soft Consumer Price Inflation Affect Fed Policymaking?
The Bureau of Labor Statistics’s seasonally adjusted Consumer Price Index for All Urban Consumers, or CPI-U, increased by 0.1 percent on the month in August. This is consistent with economist expectations, but the data also mark the continuation of a troubling trend. Inflation has been slowing down over the past few months, which is somewhat concerning given the U.S. Federal Reserve’s aggressive stimulus program.
Quantitative easing — the name given to the Fed’s ongoing purchases of agency mortgage-backed securities and longer-term Treasury securities — has four primary effects on the economy: higher inflation expectations, currency depreciation, higher equity valuations, and lower real interest rates. We have seen most of these manifest in the U.S. to some degree, but inflation data released over the past few months have come in surprisingly soft.
Headline CPI inflation was just 0.2 percent in July, which itself was down from 0.5 percent in June. Year-over-year CPI inflation is 1.5 percent, not low enough to write home about, but worth keeping an eye on. Unusually soft inflation during a period of aggressive monetary stimulus could suggest — as Fed Chairman Ben Bernanke warned about in May — that there are deflationary pressures in play.