Anyone who thinks inflation isn’t a problem isn’t looking at the numbers. It’s not a huge problem, it’s not a catastrophic problem. But it’s a problem, and it requires attention. Left untended, it’ll only get worse. And once the public thinks it’s destined to get worse, the Federal Reserve’s looking at a much bigger problem and one that could take a generation to reverse. The good news is that the problem is still manageable. Nonetheless, the clock is ticking.
Consumer prices rose 4.3% during the 12 months through last month, the Bureau of Labor Statistics reported this morning. As our chart below shows, that’s near the peak for the past 10 years. Core inflation (which excludes food and energy prices) is also pushing higher these days, running at a 2.5% annual pace, which is near its highest levels in recent years too.

Headline inflation is now far above the overall growth rate of the economy, which expanded by a paltry 0.6% in annualized real terms in last year’s fourth quarter. Even GDP’s 3.2% growth in nominal terms remains comfortably under CPI’s pace.
The inflationary pressure is all the more troubling with the Federal Reserve aggressively lowering interest rates of late, a course which increasingly looks like the monetary equivalent of throwing gasoline on a fire. Fed funds are currently 3.0%, down from 5.25% as recently as last September. As a result, Fed funds are now negative in inflation-adjusted terms. And more rate cuts may be coming. The April ’08 Fed funds futures contract is priced in anticipation of another 50 basis-point cut, which would bring rates down to 2.5%, or nearly 200 basis points below CPI’s pace.
Meanwhile, no one should mistake the inflationary momentum as a statistical artifact. The bubbling pricing pressure is evident in several crucial corners of goods and services. Food, energy, transportation and medical care prices are all advancing at annual rates above headline CPI’s pace, according to the government’s report today.
The Fed has been expecting that the slowing economy would take the edge off inflation. So far, however, nothing of the sort is happening. As GDP’s pace has slowed, inflationary pressure has only risen. So much for wishful thinking. That leaves the traditional solution, which is one of embracing a hawkish monetary policy, at least relative to what currently prevails. That’s an awkward prescription in an election year, especially one in which recession threatens. But no one ever said that running a central bank is a short cut to popularity. It remains to be seen just how much popularity Mr. Bernanke and company seek.