Why low inflation in the US shows that resources are being wasted

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Low inflation

Inflation is one of the major causes for interest rate fluctuations in the economy. Certain exchange-traded funds (or ETFs) like the ProShares Investment Grade-Interest Rate Hedged ETF (IGHG), which has its major holdings in companies like Citigroup Inc. (C) and JP Morgan Chase & Co. (JPM), the Vanguard Short Term Corporate Debt ETF (VCSH), and the PowerShares Senior Loan Fund (BKLN) are designed to protect investors against interest rate risk caused by inflation.

US Inflation rate

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The speech took an interesting turn when Kocherlakota questioned his audience on why they should care that inflation is too low. Low inflation means goods and services aren’t as expensive to buy. Kocherlakota believes that inflation has been, is, and will be too low relative to the FOMC’s target of 2%.

Kocherlakota answered the question himself by saying that people should care when the inflation rate is below the target level, as below-target inflation signals a significant problem in our economy. At a basic level, we should think of prices as a signal for how our economy is using its available resources.

Kocherlakota cited an example of an experience he had in 2012. Kocherlakota had visited Williston, on the western edge of North Dakota. As it is today, when he had visited Williston, it was in the heart of a major oil boom. That boom was pushing hard on the physical resources—like roads, water, and housing—available to Williston and pushing hard on the human resources available to Williston. The result was relatively high inflation.

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So, when inflation is high compared to the Fed’s target, like it was in Williston, we know that demand is pushing hard on available resources. The converse is also true: inflation is low compared to the Fed’s target when the demand for goods and services is too low to fully use the available resources in society. “The low inflation in the United States tells us that resources are being wasted,” he said.

Kocherlakota went on to explain what these wasted resources are. He considers his fellow Americans, referring to human resources, as the biggest and most disturbing wasted resource. There are many productive people in the United States available to work more hours, but society is deprived of their production.

The key point that Kocherlakota tried to make here is that the FOMC has been undershooting its price stability objective and is expected to continue to do so, but this typically means that the FOMC is also underperforming on its other objective of promoting maximum employment.

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