Thursday, July 23, 2015

Increasing Disinflation and the Federal Reserve is Helpless Against It

While none of us like paying higher prices for things, most economists agree that an inflation rate between 2 and 3 percent is a good thing because it shows that there is normal consumer demand for products and services.

When inflation goes above 3 percent, the economy is running too hot and those in poverty and people on fixed incomes are being hurt by high prices.  In this case, our central bank, the Federal Reserve, would step in and force higher interest rates.  Thus, the money supply becomes constricted and, in theory, an overheated economy will contract enough to get back into that 2-3% sweet spot.

One the other hand, when inflation is below 2%, it shows that consumer demand is too low; usually because of tepid or low wage growth. Then, sellers of products and services must compete more fiercely to attract customers by slashing prices or keeping prices low.  Businesses that can't lower or hold prices would typically go under. In this situation, the Federal Reserve would normally lower interest rates to kick start a weak or weakening economy in an attempt to keep it from falling into recession and to stem any job losses and business closures.

To that latter paragraph, here is this ten-year chart from the site

Since 2011, when inflation hit a peak of 3% following the 2007-2009 recession, each successive year thereafter has seen disinflation (a decline in the rate of inflation) to the point that, now, in 2015, inflation is actually slightly negative.  Economists call this condition deflation. Essentially, American wages have stagnated to a point that consumers are unable to buy at the same levels as the year before.  This explains why dozens of retailers are being forced to close stores.  McDonald's will close 700.  Walgreens 200.  Staples, OfficeMax, and Office depot are closing a combined total of nearly 600 stores.  Radio Shack has gone belly-up and will close 1784.  With all of these store closings, plus hundreds more from other retailers not listed here (see link below), this year is beginning to look like the start of a recession.

So, what can the Federal Reserve do to avoid one?  Absolutely nothing. Since the beginning of the 2007-2009 recession, the Reserve has been holding interest rates between zero and 1/4 of a percent. Therefore, there's no room to lower them in order to stimulate the economy.  In fact, insanely, it appears that the Federal Reserve might actually raise interest rates. If I'm right, this action would only exacerbate disinflation because it will do the very opposite of what's needed.


Chart Source: Current US Inflation Rates: 2005-2015:

2015 Store Closing Roundup: Radio Shack, Wet Seal, Sears, Target, etc.:

Fed leaves interest rates unchanged -

If the Fed raises interest rates, what's your move?:

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