Low Rates, High Expectations
By JAMES GRANT

Inflation is returning to the American checkout counter under the unlikely sponsorship of the Federal Reserve. For the past year, the Fed has been striving to make the dollar buy less. It's well on its way to succeeding, to judge by the recent readings on wholesale and consumer prices.

Why the Fed decided to propagate inflation, after having so long battled against it, is a story that begins with the return to common usage of an old word. Late in 2002, officials began to warn of the danger of "deflation," or broadly falling prices. Everyday low prices are well and good, the central bankers allowed. Yet if prices steadily and predictably fell, people would stop buying things. They would stay home to wait for tomorrow's guaranteed lower prices. And if the American consumer stopped shopping — and borrowing to shop — where would we be?

…Now the 1 percent era is fast closing, and financial markets worldwide are shuddering. As the signs of inflation multiply, the Fed finds itself in a very interesting position. It never wanted much inflation, it protests; just a whiff would suffice.

But the subjects in the central bank's monetary experiment are human beings, not laboratory mice. When people sense that prices are going to rise, they take steps to protect themselves. They buy extra inventory, invest in so-called hard assets (houses, not bonds) and pass along their rising costs as best they can. Once instilled, inflationary habits are hard to break, as the Fed exactly understands.

…The Fed has another reason to be conscience-stricken. It knows, or should know, that by trying to make the dollar cheaper, it has precipitated even more borrowing in an economy heavily encumbered. The greater the debt, the more deflation-prone the economy. And the more deflation-prone the economy, the more the Fed is apt to try to cheapen the dollar. The truth is that the central bank of the United States is chasing its tail.