Top Harvard Economist Warns Inflation Is Running Above 2%

My favorite Keynesian economist, Martin Feldstein, chairman of the Council of Economic Advisers under President Ronald Reagan and currently a professor at Harvard, nails it in today's WSJ:

Inflation is rising in the United States and could become a serious problem sooner than the Federal Reserve and many others now recognize. There are three basic reasons why the Fed is too optimistic in its current forecast that inflation will remain below its 2% target until after 2016.

First, data indicate that prices are already rising faster than 2% and have accelerated in recent months. Second, the low rate of short-term unemployment may be creating pressure for faster inflation despite the large total number of unemployed and underemployed individuals. And third, the rhetoric of Fed officials indicates that the central bank may not react quickly and aggressively enough if inflation continues to rise above 2%

The Federal Reserve's preferred measure of inflation—the price of consumer spending excluding food and energy—rose 1.4% over the past 12 months but increased since February at a 2.1% seasonally adjusted annual rate. Producer prices for the same goods and services have been rising over the same time period by 3.6% annually.

And he knows the Fed won't act quickly enough to battle the inflation:

  Federal Reserve officials have made statements that suggest the Fed may not act quickly and strongly enough to limit a rising rate of inflation.[William] Dudley  [president of the NY Fed] expressed a common Fed opinion when he said recently that he believes the federal funds rate will rise relatively slowly from its current near zero level, adding that he expects the equilibrium real short-term interest rate will remain lower than its historic average and less than 2% even when the existing headwinds have dissipated.

The key to the future is how the Fed will respond when prices steadily rise above its 2% target rate while the overall unemployment rate is still relatively high. A misinterpretation of labor-market slack, and a failure to create a positive real federal-funds rate, could put the economy on a path of rapidly rising inflation.

-RW