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October 15, 2012

Signs of Inflation and Time

By Stacy Pruitt via QFinance

Economists are always trying to predict the next bubble or decipher the previous bubble. One dragon that is beginning to show its head is inflation, based on past patterns that parallel current economic trends. China and India are busy fighting inflation as are other regions and it's a common theory among economists that the U.S. could be next. This article talks about the next economic dragon the world will face, inflation.

Popular Consensus 

According to Economist Kevin Kliesen, the most optimistic financial forecasters look at inflation as a potential threat. He says the consensus expects inflation over the next 3-5 years to be no larger than 2%, but there are potential risks, such as another economic downturn, that could result in severe inflation. He argues that inflation disagreement deals with comparing inflation forecasts across the board between those who sway towards high inflation, low inflation and the possibility of deflation.

The state of the Federal Reserve's balance sheet, and its effects on the monetary base, all point to possible inflation in the future. He mentions the stimulus package, pointing out how its benefits are unwinding pretty quickly, yet the debt it caused will be on the national balance sheet for quite a few years.

Major Risks

Some major risks that can lead to inflation being the next dragon are asset prices, output of GDP and the federal deficit. The possibility of a period of unusually low interest rates might start to inflate asset prices. For example, some economists believe that a period of low interest rates in 2003-2004 stimulated a boom in commodity and oil prices that eventually raised the cost to consumers and businesses and led to high interest rates.

Many believe there are signs that this trend is happening again and will result in inflation. The gross national product lowering due to high unemployment rates can also lead to inflation; this has been a theory shared by many economists ever since the unemployment rate rose to 8%. Another risk is the potential for large budget deficits. Over the past years, because of the Troubled Asset Relief Program (TARP) and two stimulus packages, the budget deficit has gone over 10% of GDP. This means the U.S. is spending about 10 trillion dollars more each year than it's earning. The first step towards balancing the budget deficit is to sell treasury securities to the domestic public, or to sell them to people overseas.

The Fed's Inflation Pledge

It's important to recognize that the risk of potential higher inflation rates must be assessed against the Federal Reserve's pledge to keep interests rates low. While inflation does represent the next big economic threat based on past patterns as they relate to current trends, the Federal Reserve has made a pledge related to inflation. In the late 70's, when inflation hit unprecedented highs, the Federal Reserve pledged to never allow it to happen again. Most economists believe the Fed will stay true to their pledge and commit to price stability.

Courtesy All About Alpha via QFINANCE (EconMatters author archive here

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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