BLS data show that February year-on-year growth of the Core CPI has reached 1.1 percent, up from the recent low of 0.6 set October 2010.  All items CPI growth has reached 2.1 percent. While energy was the largest driver, most of the other CPI categories also contributed to the rise.

What are the indicators for March?  March import prices were up, oil prices were up, and the next employment cost index report, due out April 29, will likely show some gains.  Any wage and salary gains will help this job-weak recovery, but will also contribute a bit to inflation.

What does this mean?  Despite ongoing fundamental economic weakness, we have likely moved past an episode where Deflation was a valid concern. 

As an aside, it also has an implication for our real interest rate forecast.  Many nominal interest rates, especially longer Treasuries, are rising.  Thus far, we have about a 100 basis point rise in the (nominal) ten-year Treasury in the last six months.  We had a similar rise in the All items inflation rate in that same time whereas the Core inflation rate increase was about half that.  In the case of the All items deflator of the Treasury yield, the implied real rate has not changed, but with the Core deflator, the implied real rate rose by about 50 basis points.  Either way, we have yet another fundmantal indicator, real interest rates, that is not improving. 

While I no longer characterize the situation as a “Good-deflation Equilibrium” we have not moved very far from that equilibrium at this point.  However, we may be in the process of moving to an equilibrium with higher inflation than the February level.  There are reasons to believe that the current course of debt-financed expansionary fiscal policy will lead to higher future inflation.  This course of fiscal policy will likely be maintained through 2012.  It is likely we will get to a point in 2011 or 2012 where the Fed will consider raising the Federal Funds Target rate.

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Seeing a problem and knowing how to solve it are two different things.  So, we’re going to see lots of silly ideas proposed.  We’ll see demands for more government spending.  We’ll see demands for less government spending.  We’ll see demands for higher taxes.  We’ll see demands for lower taxes.  We’ll see demands for more consumer spending.  We’ll see demands for more consumer saving.

All of these recommendations can’t be correct.  In fact, they are all beside the point.  I’m not saying the proposals won’t have any impact.  They will, but the impacts will either be marginal or they will be some time in the future.  Our problem is immediate and very serious.  Here’s what we need to do to avoid a lost decade:

• Fix the financial sector
• Stop paying interest on deposits at the Fed
• Lower effective borrowing costs with an investment tax credit
• Reduce regulatory uncertainty and big-business bias
• Increase immigration

Any vigorous recovery needs a vigorous financial sector, and ours is not.  Fed policy has been ineffective, because the money multiplier has tanked, even as the monetary base soared.  There are two reasons for this: The Fed is paying banks to deposit at the Fed, and the banks–burdened with over-leveraged balance sheets, huge charge-offs, and bad assets–are in no shape to lend.  Fix the banks, and stop encouraging them to park money in Washington, and we’ll have a start on real recovery.

We have an investment problem; there isn’t any.  That’s because, even at zero, borrowing costs exceed expected returns on investments, and the future regulatory environment is extremely uncertain.  We can’t lower interest rates below zero, but an investment tax credit would effectively lower borrowing costs.  Do that and remove regulatory uncertainty, and our businesses will invest.  While we’re at it, let’s reduce big business’ regulatory advantage.

Finally, we don’t have any problems that couldn’t be fixed by a few million new immigrants.  We’d see an immediate increase in housing demand and construction.  Our inner cities would be renewed.  Our economy would see a burst of creativity, energy, and new business formation.

The post America's Lost Decade appeared first on Center for Economic Research and Forecasting.

However, inflation is not inevitable. For inflation to occur, increases in the monetary base have to be translated to an increase in money supply. This is the money multiplier that we teach in elementary macro-economics, and it depends on bank lending, something that is just not happening. Even if the money supply increases, velocity declines could offset the inflationary impacts.

We are seeing an alarming increase in deflation around the world. The BBC reported today that Japanese prices have fallen 8.5 percent in the past year. Prices have also been falling in Germany, Spain, Britain, Ireland, and Switzerland.

It is virtually impossible to imagine a recovery if the United States slips into deflation. So far, we’ve had small increases in prices. Let’s hope that continues.

The post Deflation, not Inflation, is the Worry appeared first on Center for Economic Research and Forecasting.