Critics of the Federal Reserve's policies during the current recession argue that the bargain-basement fed funds rate and the central bank's balance sheet expansion will mean a return to 1970's-style inflation. But there are a couple of reasons to doubt that this will be case.
On his Econbrowser blog, University of Wisconsin economist Menzie Chinn showed last week that both survey- and market-based inflation expectations are well-grounded, though he cautioned that dangers loom.
Coming on a little more forcefully against the idea of rampant future inflation is San Francisco Fed economist Glenn D. Rudebusch. In a research note, Rudebusch points out that Japan's recent experience with quantitative easing didn't lead to sky-high inflation. But even if price pressures did begin to crop up unexpectedly here in the U.S., Rudebusch believes it won't be a struggle for the Fed to wean the economy off of easier money:
"...the Fed's short-term loans can be unwound quickly, and its portfolio of securities can be readily sold into the open market, so there should be ample time to normalize monetary policy when needed."
The following chart gives an idea of the severity of the current recession and how low the fed funds rate would have to go in order for the Fed to meet its mandate of price stability and full unemployment.
Since there's no current mechanism for interest rates to go below zero, the Fed has had to rely on its cornocopia of new lending facilities to ease credit conditions. And Rudebusch sees central banks around the world keeping rates low and pumping funds into the economy for at least another year. For example, the Swedish central bank has already said that its key monetary policy interest rate will likely remain low until 2011.
--Zubin Jelveh