In my previous August 27th blog titled “Is it Time to Let Bush Off the Hook?”, I discussed the two primary causes of this banking/financial system recession as being housing and overleveraging of individuals, the financial system, and government. As I said in my blog, these are difficult long term problems for which there are no easy solutions…and it could take several more years before housing values and reduced debt work their way back to levels before the crash. There is one solution that can help shorten the time span and lessen the problems…a little inflation. That is what the Fed is trying to do.
With the value of homes reduced by up to 50%, many home owners are still under water and many individuals have low savings and higher debt from overextended loans on homes and losses in the stock market, the best cure is a little more inflation. That is because inflation will increase the value of under water homes. Further, the value of most other hard assets typically increases with inflation. And with inflation, the stock market will go up, the value of the dollar will go down and that will help increase exports and decrease imports. Moreover, everyone’s home values will increase. And with higher inflation, consumer demand picks up because consumers make earlier purchases before the prices go up.
The inflation rate is low by historical standards. It reached just 1.4% in June and July and the Fed has set its preferred inflation rate targets at 2.00% to 2.3%. Some believe that inflation rates as high as 3% would have more positive than negative effects, but anything higher than that would be a problem. We have plenty of room to accept more inflation before it becomes a problem.
One of the primary inflation indicators is Plant Capacity Utilization. It is currently at 71.8% for the first quarter of 2012 compared with 72.4% in the fourth quarter of 2011, and 70.8% a year ago. While 100% Plant Capacity Utilization is full capacity, a Plant Capacity Utilization of 80% is considered optimum. Inflation becomes a concern when the Plant Capacity Utilization rises to 82% to 85%. That’s when businesses start spending more on plant and equipment to increase capacity.
A second inflation indicator is unemployment. With over 13 million unemployed, we have plenty of excess labor before labor shortages lead to inflationary wage increases. Now we just want to get more people working.
There can be negative sides to increased inflation, such as higher prices for basic core comodities and food and energy. But these are typically related to the supply and demand of the individual comodities. As long as basic consumer demand remains low with the slow economy, there is little reason to believe that excessive basic core inflation will occur any time soon.
Over all, these policies are what the Fed is trying to do with its latest round of quantitative easing. In additon to inflation. quantitative easing will allow many homes and some debt to be refinanced at lower rates…with cooperation from the banking system. This too will increase the home prices. Once the economy’s growth picks up to unacceptable inflationary levels, the Fed can slow down the economy the old fashion ways by raising interest rates and reducing the money supply. But by then, the increase in the economy’s growth will result in an increase of the governement’s tax revenues and many of the excess in the economy will be gone.
Image may be NSFW.
Clik here to view.
Image may be NSFW.Clik here to view.
