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In recent Federal Reserve testimony Chairman Ben Bernanke said µoverall inflation is still quite low and longer-term inflation expectations have remained stable. « The Fed¶s preferred measure of inflation, the personal consumption expenditures index, rose a modest 1.2 percent in the 12 months to December, the most recent data shows. Core inflation, which strips out food and energy costs and which the Fed believes is a better indicator of where inflation is heading, has been near five-decade lows.´ Meanwhile the CRB Spot Commodity Index is at all time highs. When asked, consumers and company executives are reporting price pressures appearing everywhere. Food and energy prices are trending up rapidly and core inflation is increasing across the emerging economies. Who is correct ± the Central Bankers or the markets? How can there be such a divergence between what the Federal Reserve believes and what the markets and the people on the ground are reporting? The problem arises because the Federal Reserve focuses almost exclusively on measures that relate to the unemployment and what the Fed describes as the ³output gap´ to predict future inflation ± interestingly the money supply does not appear to factor into their thinking. The Federal Reserve has conveniently concluded that no inflation is possible when those metrics are high - which they are currently. As their models tell them no inflation is possible, there is no reason to reduce the current pace of monetary expansion and therefore the bail-out of the banking sector can continue uninterrupted. The idea that the models and more importantly their entire framework might be wrong never enters Federal Reserve thinking. The Federal Reserve and monetary authorities across the western markets seem willfully blind to the events of the 1970s and the possibility of stagflation that we currently face ± high unemployment, low utilization levels but still high inflation. Prior to the 1970s central bank models said that this combination of events was impossible ± of course it still happened, as reality does not respect faulty reasoning even when such august institutions as the Federal Reserve do it. The 1970s are empirical evidence that stagnation and inflation is possible today, yet central bankers continue to choose to believe their models rather than look out the window at the real world. Of course if they did, they would have to concede that their ongoing monetary activities will never benefit the real economy and are only serving to create inflation that is bad for the middle class but useful for the insolvent banking system. It goes almost without saying that this is an admission they are unlikely to ever make and so we can expect them to adhere to the ³no inflation is possible when unemployment is high´ mantra to the bitter and inflationary end.
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