Low Inflation Is a Mixed Blessing for U.S. Economy

Money Cut in Half

No money was harmed in the making of this article.

At a glance, quantitative easing has four primary effects on the economy: lower real interest rates, higher equity valuations, currency depreciation, and higher inflation expectations. Most of these effects have been evident in the ongoing economic recovery — interest rates are near record lows, the markets have never been higher, and forex is borderline competitive — but inflation, as many economists are quick to point out, has been almost problematically low.

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The latest consumer price index report, released by the U.S. Bureau of Labor Statistics, showed an increase in the average price of goods and services of 0.1 percent on the month in May, slightly below expectations for an increase of 0.2 percent. On the year, the CPI-U index is up 1.4 percent, slightly ahead of the 1.1 percent advance registered in April.

As Chairman of the U.S. Federal Reserve Ben Bernanke put it a few weeks ago in a testimony before Congress, “if anything, [inflation] is a little bit too low.”

At the beginning of the year, the Fed set an inflation target of 2.0 percent, but the economy has since struggled to maintain upward pressure on prices. In his last testimony before Congress, Bernanke warned against incipient deflationary pressures and indicated that accomodative monetary policy has played a key role in offsetting the pressure. Inflation may be below target, but it could be worse.

Much of the negative pressure recently has been in the food and energy components of the headline index. These components are generally volatile given the nature of the underlying markets, but even core measures, which strip out food and energy, have remained soft. Core CPI increased just 0.2 percent on the month in May (compared to 0.1 percent headline increase) and 1.7 percent on the year (compared to 1.4 percent headline).

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CPI-May

Source: Data from Bureau of Labor Statistics

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