Why does the Fed want to raise inflation?

Jeremy Hobson Oct 15, 2010

Why does the Fed want to raise inflation?

Jeremy Hobson Oct 15, 2010


Kai Ryssdal: There is, quite possibly, nothing we put on the radio that’s more boring than a speech by the chairman of the Federal Reserve.

That said, sometimes ya gotta do what ya gotta do.

Ben Bernanke did give a speech this morning, about how else the Fed mght unstick the American economy. Even though we all pretty much knew what he was going to say, actually hearing it got everybody’s attention.

Ben Bernanke: The FOMC is prepared to provide additional accomodation if needed to support the economic recovery, and to return inflation, over time, to levels consistent with our mandate.

To translate if I might: additional accomodation means the Fed’s going to push interest rates even lower. Getting inflation consistent with their mandate actually means getting prices higher.

From New York, Marketplace’s Jeremy Hobson has the details.

Jeremy Hobson: The Fed has already lowered short-term rates to near zero, so it’s all about the long-term rates. And to bring those down, the Fed has to buy assets like Treasury bonds — so many of them that the interest rate on those bonds begins to fall.

It’s a process called quantitative easing. And Kevin Flanagan, chief fixed income strategist at Morgan Stanley, says the effect is three-fold…

Kevin Flanagan: To reduce borrowing costs.

On things like mortgages, to aide the housing market…

Flanagan: To help more risk assets, in other words when you bring down yield levels they become less attractive and investors may want to turn their attention to other riskier type assets.

Meaning sell those bonds and buy some stocks to boost the stock market.

Flanagan: But something even more important is what it could do for exports because traditionally when you go down the path of quantitative ease, it tends to depreciate your currency.

So other countries want to buy more of our goods and the number of manufacturing jobs rises. So might the inflation rate. And a little bump would be sign that consumers are back in the game.

The Fed is hoping the inflation rate will double from 1 percent to 2, but former Fed economist Ann Owen of Hamilton College says:

Ann Owen: What the concern is is that because of the momentum, they won’t be able to stop it. It’s really hard to put the breaks on without skidding and I think that’s what the people who are concerned about inflation are worried about.

And even Ben Bernanke admitted today he’s wading into uncharted waters. But for now, deflation appears to be the central bank’s biggest fear.

In New York, I’m Jeremy Hobson for Marketplace.

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