The Year of the Dragon (of Inflation)

So, this Chinese New Year rings in the year of the Dragon.  It is supposed to be a good year for business and families.  Let's hope so.

Earlier in the week Fed Chairman Bernake said that the Fed intends to keep interest rates low (near zero) until the later part of 2014.  This is great for anyone who is interested in borrowing money, because it suggests that the price of short-term money is going to be cheap for at least another two years.


There is a fun and educational game on the Federal Reserve website that is called the "Fed Chairman Game."  Your job in the game is to use interest rates to manage unemployment and inflation in a way that helps to stabilize the US economy.


http://www.frbsf.org/education/activities/chairman/

What is entertaining here is that in the game, after 8 quarters of 0% interest rates, you have a 12% rate of inflation.  Admittedly, the model in the game is probably simpler than the real economy, and the game does not start off with 10% unemployment.  But the expected effect should be clear.  There will be inflation.

It's unclear where the inflation will manifest itself.  There has been meaningful inflation in commodity prices since the zero-interest-rate policy (ZIRP) began.  But we have not seen inflation in the cost of services, labor, or real estate.  I expect that we won't see wage inflation until unemployment is a little lower... but there is something to think about here.  The demand for "stuff" is still high and supply is flat.  Demand for people is down, and supply is _____.

The price of labor has been flat - to falling over the last 4 years.  The interest rate is essentially the price of money.  That is near zero and will remain low until 2014.  Inflation is likely to keep flowing to the price of goods until the unemployment market tightens.  So, if interest rates stay low and unemployment remains high, I would expect that inflation is will continue to be focused on the commodities and goods sectors.

MONKEY BUSINESS

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