Inflation Fears: Fed is Underestimating the Escalating Threat

Pretty much everyone but U.S. Federal Reserve Chairman Ben S. Bernanke sees that inflation is returning: After all, even Bernanke's favorite inflation measure, the Personal Consumption Expenditure (PCE) deflator, was up 0.4% in February - which hints at an annualized inflation rate of almost 5%.

What folks don't see, however, is just how bad inflation will get.

Look Beyond the Numbers

At first glance, the most recent inflation statistics are disquieting, but no more.

Bernanke would tell us that "core" consumer price inflation, excluding food and energy, rose at only 1.2% in the last six months. Overall consumer price inflation rose 0.4% in February, and has risen at an annual rate of 3.7% in the last six months.

Even Bernanke's favorite indicator - the price index for Personal Consumption Expenditures - was up 2.7% over the last six months, suggesting that inflation is indeed stirring.

The inflation "hawks" - who want Bernanke to stop buying U.S. Treasury bonds and raise interest rates - believe that the worst we'll see is a reprise of the stagflation-ridden 1970s, wheninflation rose from 3.6% in 1973 to a year-over-year peak of 14.6% in 1980.

The reality is that the United States does not have the same policy mix today as it did in the 1970s. So there's no reason to expect the same gradual inflationary escalation, which was ultimately fixed by then-Fed Chairman Paul A. Volcker's painful - but not-too-damaging - tight-money policy.

This time around, things could get much worse.

Read the rest here.