Monday, October 22, 2012

What Ben Bernanke Will Do When the Accelerated Price Inflation Hits

Many are familiar with the Ben Bernanke book, Essays on the Great Depression, which is a compilation of writings about the Great Depression by various economists.  Fewer, however, are aware that Bernanke contributed to a work on inflation, Inflation Targeting.

This second book may provide us with important clues as to how Bernanke will act if price inflation begins to accelerate. And, indeed, it appears that some time in 2013 a perfect storm of actors may develop to push price inflation much higher.

In 2013, meat prices are very likely to climb given the drought this year which caused many farmers to deliver cattle early for slaughter, rather than pay the soaring feed prices. This will mean a smaller supply of meat available in 2013. In addition, the oil price continues to react to the possibility of war against Iran and the Iranian threat to mine the Strait of Hormuz.

In addition, to these supply side factors (which can not be considered overall price inflation), on the demand side we have Bernanke printing money again, with early indications that the money is entering the system and not simply being put aside by banks into excess reserves. Thus, this increase in money supply is very likely to fuel price inflation, especially given that their are strong indications that the overall demand to hold cash is shrinking (as evidenced by climbing housing prices and stock prices).

If all these factors intensify in 2013, the price inflation could be very strong. How will Bernanke react? Probably very slowly. Indeed, while the current stated Fed price inflation target is 2% (which is where the 12 month CPI is currently at), Bernanke's real target is likely 3%. In Inflation Targeting, we have this:
Also, many economists believe (though it remains controversial) that benefits of low inflation may be realized when inflation reaches the 2% to 3% range.
What this means is that Bernanke isn't even going to worry about price inflation for another 100 basis points, and then he is likely to dismiss the price increases coming from meat and oil prices. Inflation Targeting again: all countries we have examined, the monetary policy authorities routinely allow deviations from inflation targets in response to supply shocks....For example, suppose a jump in oil prices suddenly pushed inflation from lows levels to a level above the long-run goal. In this circumstance, the inflation-targeting approach would not require an immediate draconian response....the Federal Reserve would have to explain to the public that its actions were designed to keep output and employment losses to a minimum, while still maintaining the objective of long-run price stability.
In other words, when prices start to climb because of supply factors, he will simply jawbone and not attempt to fight the increase in prices. But, what if prices are climbing not only because of  supply factors, but also because of the money printing and a decline in the desire to hold cash? This could push price inflation much higher, but only result in a modest response from Bernanke. From Inflation Targeting (my bold):
A common practice has been to distinguish between long-run inflation goal and short run targets, with the latter set to converge gradually with the former.
What about an exploding money supply, again little concern from Bernanke is likely to be the result. From Inflation Targeting:
Inflation-targeting central banks generally do not tie themselves to specific intermediate targets, such as the growth rate of the money stock...
Bottom line: The likelihood of strong price increases exist in 2013, with a very slow reaction from Bernanke. He isn't likely to be concerned about money supply growth. He will be quick to dismiss price increase as coming from the supply side (which will be partially accurate). But when prices start to climb dramatically above target, anywhere between 5% to 10% annualized increases, he is  likely to only react gradually to bring prices down. This will be a prescription for disaster, as the desire to hold cash will continue to shrink as prices climb, pushing people to spend their cash more aggressively, only a dramatic slowdown in money growth would stop the price increases at that point. And there is no indication that at such a time Bernanke will even be looking at money supply growth. In other words, a perfect storm of price inflation could hit the U.S. in 2013, including a lackadaisical response from Bernanke.


  1. So they're preempting a tightening discussion by already blaming it on the weather?

    I don't think they even discuss tightening. To do so would admit that they're partially the cause of price inflation, something they routinely deny. (if you can halt inflation by tightening, then obviously you caused the inflation by easing).

  2. I'm not voting but I am going for Obama win because Obama isn't going to spout phoney baloney free market economics that will be blamed for this potential crisis.

    1. Oh please. BOTH parties spout the same crap. Both are beholden to the private banks that control the Fed. Jamie Dimon (a democrat) IS the Fed. But it ain't about the red or the blue, its about the green. And they're getting theirs and we're getting screwed.

  3. Massive price inflation is already here. But it's being hidden. The extent of the hiding is at an end however:

    1. A Toyota Camry is so poorly built now that the owner's manual recommends a front end alignment every 6000 miles (every second oil change!) instead of every 40,000 miles as the 2005 Camry did.
    2. The number of car recalls is up 35% over the past 4 years.
    3. Cars are falling apart like crazy
    4. Toyotas and most cars now come with chinese versions of the same tire model that you can buy off the shelf. The Chinese one barely lasts to the 20,000 lemon law and the dealers are being instructed to drag out replacing the tires so that they're not subject to lemon laws. OEM tires have no warrantee New tires routinely last half of their mileage waranttee for most people now-a-days.
    5. Dog food now is mostly Soy compared to the year 2000 when it was mostly meat with a little soy. Since 2007 the size of the large breed dog food has gone from 50 pounds to 38 pounds (and that's advertised as 3 bonus pounds!) and the price has increased from $17 / bag to $23 / bag at Walmart. Dogs are getting fatty tumors as a result AND the stuff is 30-40% more expensive in the past 5 years.
    6. Buy knife sets, kitchen utensils etc. My mother has a knife and plate set from 1970. She's dropped plates, and knifes etc. with no issue. Still has the full set minus I think one plate. It cost her $60 in 1970. Now you can't buy a set for under $100 and it will last you a year or two at most. Knives wear out and can't be resharpened and cost more than the knife that was lifetime back in the day.

    The list goes on. Everything is CRAP now.

    And anyone notice how much of stuff is broken and has been broken for a long time? Gas pumps that can't print receipts or take credit/debit cards at the pump, washrooms in theaters that are out of order and have been for months etc. etc.

  4. Both Keynesians and Chicago Schooler's agree with the Austrians. But they cannot admit that their policies creates bubbles. Remember the policies were introduced to reflate bubbles, not to prevent them. Think of the equity losses of Keynes and Fisher from 1929-1932.

  5. Bernanke was hinting at increasing the long term inflation target almost exactly a year ago. I wrote about it here:

  6. I've wondered, what would stop the Fed from issuing some new form of debt, like Fed Bonds, in order to begin soaking up some of the money it has printed, once it's obvious to them that inflation is getting out of control? That way they wouldn't have to sell treasuries or MBS.

  7. Yes, I agree his response will be slow. Even if they replaced Bernanke with a Volcker today, there may be no change in outcome. It is quite possible that by the time the FED considers tightening, its balance sheet will contain mostly long dated bonds and MBS paper.
    If they start selling long dated paper they would instantly crash the bond market; and because of the declining prices for bonds the measure would fail to reduce the money supply meaningfully.
    This is the end... my only friend, the end...
    When will this happen? Mercifully, nobody really knows.

  8. They will use every dirty trick in the book to keep the scam going, except actually fix it. I think we will look a lot like Africa in the coming years. I doubt there will be a collapse more like a slow death. it would be interesting to see the military step in though.