The Inflation that Concerns the Fed Does Not First Affect Food and Energy Prices

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Friday, 14 September 2012 05:16

In an article on the Fed's decision to buy more bonds and to extend its commitment to a low interest rate policy, the Washington Post told readers:

"Fed officials have been sympathetic to concerns about inflation, which would first affect middle-class purchases of necessities such as food and gas."

Actually, inflation in food and gas prices is of the least concern to the Fed because they are largely out of its control. The price of food and gas are determined in international markets. When these prices have risen it has been primarily because of rapid growth in demand in developing countries like China and India, or reductions in supply due to political disruptions or weather. (In many cases the price rises were amplified by speculation.)

The Fed's actions will do little to affect worldwide demand for these products and therefore will have little effect on the price of food and gas. This is why the Fed generally looks at the core inflation rate, which excludes food and energy prices, in designing policy. The non-core components are both much more volatile and outside of the Fed's control.

This piece also inaccurately asserts that the labor market has been worsening over the last three months because the economy has only been generating 100,000 jobs a month. The piece claims that it needs 120,000 jobs a month to keep pace with the growth of the labor market. In fact, the Congressional Budget Office projects labor force growth of 0.7 percent a year. This would imply that a growth rate of 90,000 jobs a month is sufficient to keep pace with the growth of the labor force. By this measure, job growth has just been keeping pace with the rate of growth of the labor force.