Fed policy is not a threat to price stability – at least short term

There are plenty of reasons to be worried that inflation might become a problem down the road, including the Fed’s seemingly unlimited appetite for creating money and buying U.S. Treasuries.

But with the economy slowly emerging from the worst recession in 70 years, still high unemployment and very modest wage gains remain powerful forces that are preventing businesses from enacting all but small price increases at the present time.

Yesterday’s release of the labor report, which also includes a look at wages, provides us with a good opportunity  to evaluate one anti-inflationary force that is still entrenched.

Average hourly earnings barely increased in November, and year-over-year, rose 1.6%versus a 1.7% rise in the prior three months (see chart 1).



As reflected by the chart above, the general downward trend remains intact, but it has eased over the past year.

This simply means that the high rate of unemployment and the very abundant pool of labor allow businesses the luxury of keeping wage increases to a minimum. And many are feeling queasy when it comes to demanding larger raises given the lingering job insecurities that remain.

Consequently, the largest expense for most firms is relatively stable, alleviating the need to boost prices in order to maintain profit margins.

Of course, there are exceptions.

Firms that manufacture goods are feeling the sting from rising commodity prices and are being forced to pass along some of the higher costs.

However, there is plenty of capacity still available and relatively sluggish demand makes it difficult for many to fully pass along higher raw material prices to customers.

If economic growth were to markedly accelerate, and that seems unlikely in the near term, the Fed’s pump priming machine has the potential to ignite broad price hikes throughout the economy.