As fragile world economies slowly recover from recession, experts look to two sources to determine whether deflation or rampant inflation might be the next great challenge: the Federal Reserve Bank and Wal-Mart.
On Thursday, February 18, the Fed raised the interest rate it charges banks for emergency loans, attempting to wean private banks from public assistance as the economy works its way from recession to recovery. Investors and bankers perceived this move as a “shot across the bow” indicating higher overall rates in the future. Javier Hernandez writes in The New York Times, however, that, “A report on consumer prices suggested that inflation appeared to be largely in check, despite a period of extraordinarily low interest rates.”
Those low interest rates are part of the fear factor, because the government’s massive and fast-rising debt, like almost everyone else’s massive and fast-rising debt, has been fueled by the low cost of money. As interest rates rise, the Fed will likely fire up the old printing presses, and the specter of hyperinflation will rear its ugly head.
Some point out that calling inflation “largely in check” is putting it mildly. Agnes T. Crane (Reuters Breaking Views, February 19, 2010) noted that among policymakers, fears of deflation have been replaced by fear of rampant inflation, but among retailers like Wal-Mart, “the battle on the ground is still against corrosive falling prices, not rising ones.”
According to Crane, price declines on food items and consumer electronics dragged Wal-Mart’s same-store sales down 2% for the quarter ending in January. Producer prices have risen slightly in the last quarter, and it remains to be seen whether those increases can be passed on to consumers, or whether profits will be squeezed even further.
In our complex, consumer-driven economy, inflation and deflation both present serious threats at this time. Economic growth produces a small amount of inflation as a by-product, so although most of us grew up despising inflation, this crisis reminds us that inflation is the lesser of economic evils.
The trick to stimulating growth, and one of the key purposes of the Federal Reserve, is to control inflation, not prevent it completely. By definition, a recovery for Wal-Mart and other retailers means higher prices for consumers: inflation. If those higher prices can outpace producer price increases and lead to higher profits, employers will hire more workers, increasing consumer income and demand, stimulating the overall economy.
All eyes are on the Fed as they tinker with interest rates and monetary policy to influence behavior of banks and markets, but consumer behavior will ultimately define the scope and timing of recovery. Investors might be wise to keep one eye on the Fed, and one eye on Wal-Mart.