Low inflation and high growth...not for much longer
23rd July 2006

Despite the political blows both George Bush and Tony Blair have faced, they have kept winning the elections and for essentially the same reason – both their economies have flourished. But this may not be the case any longer for America, and bad news for them will spell out bad news for Britain and the rest of the world.

Unusually, America has been enjoying low inflation along with high economic growth but this cannot continue for much longer. Either inflation will grow or economic growth will slow down eventually leading to higher unemployment.

There are two reasons for this ominous prediction. Firstly, the statistics have hinted at stagflation where there is higher inflation and higher unemployment and secondly, the Federal Reserve is reluctant to adopt policies that could cure stagflation as it would be highly unpopular.

Gloomy statistics

The current slowdown in the housing market which has now become a rout has come about too late to dampen the rate at which inflation is rising, which has reportedly jumped to 4.3%. Washington has toned down this figure blaming rising prices but this argument is weak as core inflation figure are also on the rise.

But the Fed argues that the core inflation has also been distorted by housing costs. However, inflation is now not confined to the housing market, as it spreads rampantly through the US economy. The problem with core inflation is that it depends on the definition and the Fed seems to be changing it to suit its agenda.

Reluctant Bernanke

Ben Bernake, the Fed chairman seems to ignore the rough waters ahead and instead promises that the trend of inflation will be reversed without any pain at all. The Fed also insisted explicitly that it would maintain this rapid growth rate of 3 to 3.5 per cent.

Bernanke seems to insist that the US economy can control inflation and maintain high economic growth without suffering from brief unemployment.

Bernanke obviously seems to know something that we don’t know.

Sources - summary of:
The Times - You can't just wish it away: inflation is back on both sides of the Atlantic