Inflation

This topic contains 6 replies, has 2 voices, and was last updated by  TS Paul 2 years, 11 months ago.

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  • #18480

    Anne
    Participant

    The last paragraph the article TS Paul posted to twitter

    “Most important of all to the cycle is the start of inflation. Once we see a few consecutive quarters of higher prices, the economy begins to overheat. This forces the Fed to pay attention and eventually to act. Fear of inflation scares the Fed into a tightening cycle; typically, it will tighten at three, four or even five meetings in a row. This reduces available credit, makes the credit that is available more expensive, and — voila! — a recession occurs.”
    https://www.washingtonpost.com/business/get-there/what-are-the-chances-of-a-recession-not-what-youd-think/2016/04/01/2a416efa-f4f4-11e5-9804-537defcc3cf6_story.html

    What I don’t understand is why the Fed’s goal is to get total inflation up to 2 percent and tying it to their decision of raising the interest rate if that will lead to a recession? The inflation rate was between 1.5 and 2.1% between 2012 and 2014 with no change to Fed Rate and in 2015 when inflation was well below 1%, the FED raised rates for the first time. Can anyone explain why FED sees inflation as good and why they didn’t raise rates much sooner?

    #18481

    Anne
    Participant

    Note: quote above was in middle of article. Long blank space following paragraph deceived me.

    #18490

    TS Paul
    Keymaster

    The most basic reason is the Fed believes that some low level of inflation is necessary to drive spending, which makes businesses more profitable, which means they can hire more and pay their workers more, which means those workers will spend more.

    The first bit is the tricky one, but the idea is that consumers will make purchases now (which initiates this golden cycle) rather than waiting if they believe that prices are likely to go up, even a little bit. In contrast, if prices are flat or declining, consumers have every incentive to postpone purchases, which keeps the cycle from starting.

    Another key effect is that inflation allows people and companies which borrow to pay back that debt with funds which are less valuable than the money which they borrowed. Borrowing leads to more spending, which gets us back to the basic reason.

    Keeping interest rates low even when the inflation rate met exceeded their target made sense to the Fed a few years ago because the unemployment rate was still higher than their “full employment” target. So those low rates led to more borrowing which led to more spending. Now that the unemployment rate has fallen into their target range, they want to make sure that inflation doesn’t get out of control, so they will raise rates to try to slow spending.

    The reason we have business cycles is because this is not an exact science and there are other inputs as well. At some point, things will get pushed too far in one direction or the other and we will have to live through the economy rebooting itself again.

    The TSP Allocation Guide www.TSPallocation.com

    #18491

    Anne
    Participant

    TS, Thank you for the response. I think all the monetary policy/QE has distorted the market/business cycle. A good reboot might just do us some good.

    #18492

    Anne
    Participant

    BTW…just dawned on me how you came up with your alias here…TSP:) Yes, I’m a little slow at times!

    #18498

    TS Paul
    Keymaster

    🙂

    The TSP Allocation Guide www.TSPallocation.com

    #18499

    TS Paul
    Keymaster

    🙂

    The TSP Allocation Guide www.TSPallocation.com

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