Note to Fed: Low Inflation Is a Feature Not a Bug

By  Dr. Merrill Matthews Institute for Policy Innovation. The Federal Reserve Bank is in handwringing mode again as it frets that it cant seem to push inflation up to its targeted 2 percent rate. But while a sub-2 percent inflation rate may be a defeat for the Fed its a victory for the economyand our pocketbooks. The Fed is obsessed with a fear that the U.S. might return to a period of deflation which is marked by a general decrease in prices. The concern is that people will refrain from buying in a deflationary period hoping prices will move even lower. Of course Wal-Mart Amazon and the Internet help people find lower prices every day!  And when they find what they believe is a good deal they buy. But the deflation fear is overblown. According to the U.S. Inflation Calculator in the 77 years since 1940 there have only been three years when the U.S. experienced negative average annual inflation ratesi.e. deflationand the last one was 27 years ago. However there were six years of negative annual inflation rates in the 1930s during the Great Depression. But thats exactly what youd expect in a depression. By contrast there have been 20 years where the U.S. inflation was 5 percent or more and six exceeding 10 percent. Economists used to think that inflation was the real threat to an economy while low inflation has numerous benefits because it:

Protects seniors savings. Inflation decreases the value of each dollar making debtors better off than saverse.g. seniorswhich is one reason why debtor governments have historically embraced higher inflation rates. However low inflation also reduces or eliminates recipients Cost of Living Adjustment (COLA) increases to Social Security payments which is bad for seniors but good for the economy. Keeps federal interest payments lower. Speaking of debtors the federal government must pay interest on its $20 trillion in debt$433 billion in 2016. Higher inflation would almost certainly mean significantly higher interest payments. Keeps expensive items more affordable. Low inflation keeps both prices and interest rates lower for houses automobiles and consumers goods that people are likely to finance. Implies economic stability. We typically associate runaway inflation with banana republics run by despots. Low to zero inflation sends a message of economic stability. While the economy often adjusts to higher inflation by driving up the price of everything it can lead to an inflationary cycle thats hard to contain (e.g. 1979-81). The Fed will likely continue its efforts to micromanage the economy in the hope of reaching a 2 percent inflation rate. But as long as it fails the rest of us win.

Todays PolicyByte was written by Dr. Merrill Matthews resident scholar with the Institute for Policy Innovation.