Core inflation picks up

The core personal consumption deflator (a much broader measure of ex-food and energy prices than the core CPI) rose 0.3% in April, higher than expectations. By this measure, inflation has actually been accelerating this year, rising at a 2.5% annualized pace from December through April. As I've been point out for quite some time, the mere fact that core inflation is not declining is quite significant; that it is in fact accelerating is icing on the cake.

Conventional economic wisdom holds that during periods of recession, especially with the economy as weak as it has been in the past 6-8 months, inflation should decline significantly. Indeed, the theory of inflation that the Fed likes to use says that the existence of plenty of economic slack—where the economy is operating significantly below its potential—should exert downward pressure on prices. Well, it's not happening. This lends credence to the monetary theory of inflation, which says that inflation rises when the Fed is accommodative and willing to oversupply the world with dollars, as they are today.

At some point the Fed is going to be faced with the uncomfortable fact that inflation is higher than it has been expecting. The bond market is already beginning to notice this, since yields on T-bonds have risen quite a bit this year, and measures of the bond market's inflation expectations have also moved up. The simple truth is that the Fed has been too easy for too long, and they should be tightening. The longer they wait to tighten, the worse the inflation problem is going to become. In the meantime, we can be confident in saying that there is plenty of money out there in the world, and that monetary policy is not doing anything to prevent a recovery from taking place.