Why We Don’t Need to Worry About Ben Bernanke’s Helicopter An Insight into the Nation’s Inflation Situation Bill Armstrong Fed Challenge March 18, 2010

FOMC Release- March 16, 2010 Information received since the Federal Open Market Committee met in January suggests that economic activity has continued to strengthen and that the labor market is stabilizing. Household spending is expanding at a moderate rate but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software has risen significantly. However, investment in nonresidential structures is declining, housing starts have been flat at a depressed level, and employers remain reluctant to add to payrolls. While bank lending continues to contract, financial market conditions remain supportive of economic growth. Although the pace of economic recovery is likely to be moderate for a time, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability. With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period. To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve has been purchasing $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt; those purchases are nearing completion, and the remaining transactions will be executed by the end of this month. The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability. In light of improved functioning of financial markets, the Federal Reserve has been closing the special liquidity facilities that it created to support markets during the crisis. The only remaining such program, the Term Asset-Backed Securities Loan Facility, is scheduled to close on June 30 for loans backed by new-issue commercial mortgage-backed securities and on March 31 for loans backed by all other types of collateral.

Implications of Our Current CPI Expectations for the year are consistent with disinflation If we are sitting at 0.0% Headline CPI, further decreases in inflation will essentially lead us into deflation. This concern is somewhat pushed back by the higher Core CPI at.1%, but even still, we don’t have very far to go down before reaching the zero point.

Why? (Near) Double digit unemployment rate Little to no wage growth Resource slack in manufacturing Business’ lack of pricing power

Wage Rates Disposable income lower than reported due to lowered revisions to wage income and increases in tax payments. Since spending growth remains moderate while this is occurring, it means that rebuilding balance sheets has taken a back seat to spending. Wage income is improving, so in the future, inflation may once again become a concern- it will, however, be a while until this point is reached. This is consistent with the moderation in job losses and stabilization of unemployment.

Unemployment to Wage Rates With unemployment near 10%, labor market power is clearly in employers' hands, so there is little prospect for much more acceleration in wage income until hiring resumes One additional question is bonus payments. The BEA usually includes an explicit assumption about how they will impact first quarter wage income in the January data, but none was made today.

Long Run Income Support From a longer-run perspective, however, the main support to spending is the government. Aside from specific supports to vehicle, house and appliance sales, transfer receipts dominate income growth on a dollar basis. Wage income is tracking 1% below its year-ago level, although the pace of decline is narrowing. Dividend income is still nearly 13% below its year-ago level, despite strong growth late last year. Transfer income is up 12%.

Future Spending Cycle Consumers seem willing to grow their spending modestly at the cost of a slow rebuilding of their balance sheets. This pattern seems likely to continue, supported by a resumption of job growth soon (hopefully), although clearly risks lie to the downside if unemployment rises or house prices fall again in coming months.

In Summation Inflation isn’t a concern because the Fed is winding down their balance sheet, and the risks from the increased liquidity in the market are, in my opinion, and seemingly in the Fed’s opinion, partially, if not completely, offset by the weakened conditions in the market. Growth in the market has been slow, recovery is decelerating, but still obviously present Inflation may become a risk once more if the recovery pace picks up and/or business prospects begin brightening (hiring, etc)