Is Inflation Returning?

Inflation is now low in every industrial country, while high unemployment and slow GDP growth removes the usual sources of upward pressure on prices. Nevertheless, investors are increasingly worried about future inflation, owing to the large expansion of commercial bank reserves engineered by the Federal Reserve and the ECB.

CAMBRIDGE – Inflation is now low in every industrial country, and the combination of high unemployment and slow GDP growth removes the usual sources of upward pressure on prices. Nevertheless, financial investors are increasingly worried that inflation will eventually begin to rise, owing to the large expansion of commercial bank reserves engineered by the United States Federal Reserve and the European Central Bank (ECB). Some investors, at least, remember that rising inflation typically follows monetary expansion, and they fear that this time will be no different.

Investors have responded to these fears by buying gold, agricultural land, and other traditional inflation hedges. The price of gold recently reached a four-month high and is approaching $1,700 an ounce. Prices per acre of farmland in Iowa and Illinois rose more than 10% over the past year. And the recent release of the US Federal Reserve Board’s minutes, which indicate support for another round of quantitative easing, caused sharp jumps in the prices of gold, silver, platinum, and other metals.

But, unlike private investors, Fed officials insist that this time really will be different. They note that the enormous expansion of commercial banks’ reserves has not led to a comparable increase in the supply of money and credit. While reserves increased at an annual rate of 22% over the past three years, the broad monetary aggregate (M2) that most closely tracks nominal GDP and inflation over long periods of time increased at less than 6% over the same three years.

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