Federal Reserve Has New Worries About Inflation Rate

After years of concern about prices and wages going up too much, central banks are worried about too little inflation. Linda Wertheimer talks to David Wessel of the Brookings Institution.

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LINDA WERTHEIMER, HOST:

For much of the past half-century the Federal Reserve and the Central Banks of other major economies have worried about too much inflation. But lately their worry has been the opposite - too little. The U.S. government releases the latest consumer price index data tomorrow. Joining us now to tell us what to expect and to explain why low inflation is now the enemy is David Wessel. He's the director of the Hutchins Center at the Brookings Institution, and a contributor to The Wall Street Journal. David welcome.

DAVID WESSEL: Good morning.

WERTHEIMER: So what are the inflation gauges reading now?

WESSEL: Well, in the United States the consumer price index has been rising about a 2 percent annual pace. But the inflation gauged that the Fed favors - it's called the personal consumption expenditures price index, clearly not chosen because the words trip off the tongue. It' been running well below the Fed's target of 2 percent for the past 12 months. Now we get updated forecasts from the Fed later this week, but the last one showed that most Fed officials show - expect inflation to be below the target well into 2016. It's been rising at about 1.6 percent over the last 12 months. Now, a lot of people are skeptical of these government numbers because they tend to remember the prices of things that go up and ignore the prices of things that go down. But the best data show us that prices are rising very slowly here in the United States, and the problem is even more acute in Europe. The countries that share the euro currency have reported inflation of just 0.5 percent for the last 12 months, which is why their central bank has been getting increasingly aggressive.

WERTHEIMER: David we're told repeatedly that inflation is a very bad thing, the cost of living rises, prices go up, something to be avoided. So how can too little of a bad thing be a bad thing?

WESSEL: Well that's a good question. (Laughing) So too much inflation is definitely bad for an economy, but so is too little inflation. I mean it sounds appealing, prices going down, people paying less at the store. But when inflation is low that means wages are going up very slowly too. That's of course not very popular. There are a couple of problems with too little inflation. It can be a symptom of a lousy economy, one in which demand for goods and services and workers is anemic. It can make it hard for the Fed to spur borrowing because it's hard for them to get the interest rate below the inflation rate. Particularly once rates hit zero as they did in 2008 and have remained there, and it also means that an economy is closer to what they call deflation which is a generalized decline in wages and prices and that's not healthy.

WERTHEIMER: And deflation is how serious?

WESSEL: Well it's very hard for an economy to prosper when wages and prices are falling. That's been a problem in Japan for the past couple of decades. Yeah when prices and wages decline incomes decline, but the amount of money that you owe does not fall. So you get less money every month but your monthly payments on your debts do not fall, and that can be a very insidious development in an economy.

WERTHEIMER: You know, David, I wonder if the tools of the Federal Reserve are exhausted in terms of stimulating the economy as you suggest. What do you do then?

WESSEL: Well, that's a good question. So it used to be that economists believed that a central bank can always create inflation by printing more money. But lately it's been -seems harder to do that than the textbooks had told us. An interesting case is Japan where only when the government - the elected government and the central bank got together and said we're going to do whatever it takes to create inflation, running deficits, printing money, talking about inflation has managed to get the inflation rate closer to their target above zero finally for the first time in years.

WERTHEIMER: David, thanks very much.

WESSEL: You're welcome.

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