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Economy

Inflation Is Still Too Low


The consumer price index (CPI) rose slightly less than expected in January, increasing by just 0.2 percent instead of the 0.3 percent gain that economists surveyed by Bloomberg had forecast. Still, prices are 2.9 percent higher than they were 12 months ago. That shouldn’t be confused with the 2 percent inflation target set last month by Federal Reserve Chairman Ben Bernanke. That’s based on the personal consumption expenditures price index (PCE), which tends to increase by about one-third percent less than the CPI.

Bernanke has said that he chose to base the Fed’s inflation target on the PCE because it’s a better reflection of the changes in people’s purchasing habits. One of the big blind spots of the CPI is that it doesn’t capture how people adjust to fluctuating prices by substituting cheap goods and services for those that grew more expensive.

Bernanke’s target is also a long-run target and not something to be evaluated every month, or even quarter. He’s hoping PCE inflation will average 2 percent over the next decade or so.

Given the considerable slack that remains in the economy, some economists still expect inflation to stay relatively low. But a bit more of it wouldn’t necessarily be a bad thing. “A bit more inflation would probably aid the recovery,” says Justin Wolfers, an economist at the Wharton School of Business. Given the Fed’s dual mandate of maintaining stable prices and achieving “maximum employment,” it has to tailor its approach based on how it’s doing on each measure. “The Fed is saying we care about both employment and inflation and when one is bad, we’ll tolerate a little more of the other,” says Wolfers.

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Philips is an associate editor for Bloomberg Businessweek in Washington. Follow him on Twitter @matthewaphilips.

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