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Bernanke determined to thwart inflation's ravages

By ASSOCIATED PRESS
Published June 28, 2006

WASHINGTON - Federal Reserve chairman Ben Bernanke has made clear he'll go to the mat to knock down inflation, increasing the likelihood that interest rates will rise again at the end of the Fed's two-day meeting Thursday.

Other Fed chiefs also have sought early in their tenures to show their inflation-fighting resolve. Here, in question-and-answer format, are some basics about inflation.

What exactly is inflation?

A rise in the prices of goods and services. In economist-speak, inflation occurs when too much money is chasing too few goods.

Why is the Federal Reserve concerned?

Once inflation gets a grip on the economy, it can be hard to break. A rapid rise in prices erodes the purchasing power of consumers. It can squeeze companies' profits, too, and that can make employers reluctant to hire workers and boost capital spending. It can diminish returns on investments. If consumers and companies clamp down on spending in response to rising prices and interest rates, the economy can be thrown into a recession.

How does the Fed treat inflation?

The Federal Reserve boosts interest rates. Those higher rates make it more expensive for consumers and businesses to borrow. That can curb their appetite to spend, which in turn can moderate economic growth and that can lessen inflation pressures.

The goal for Bernanke and his colleagues is to push up rates enough to quell inflation but not so much as to tip the economy into recession. It's a tricky task.

When was the United States' last major bout of inflation?

Inflation flared past 12 percent in 1974, calmed down and then boiled over at the end of the 1970s and into the early 1980s. Paul Volcker took over the Federal Reserve in 1979 and that year inflation - as measured by the consumer price index - jumped 13.3 percent.

That was up from a big 9 percent increase in 1978 and marked the largest increase since 1946, when wage and price controls lifted after World War II sent prices soaring by 18.1 percent, economists say.

In 1980, consumer prices jumped by 12.5 percent. Eventually prices settled down after Volcker ratcheted up interest rates to levels not seen since the Civil War to get inflation under control.

But Volcker's successful inflation battle did have a price: two recessions in the early 1980s and the nation's monthly unemployment rate soared past 10 percent.

What are current barometers saying about inflation?

Although inflation is picking up, the situation is not even close to approaching the double-digit inflation dangers of the '70s and early '80s. Consumer prices for the first five months of this year raced ahead at an annual rate of 5.2 percent - outpacing the 3.4 percent rise for all of 2005.

Core prices, which exclude food and energy, are advancing at a 3.1 percent pace so far this year. That compares with a 2.2 percent increase in 2005. Fed policymakers pay close attention to measures of core inflation.

If inflation takes off, what does it mean for me and my pocketbook?

You'll be paying more for goods and services. If those prices are going up faster than your wages, your paycheck in effect will shrink, straining your budget and your lifestyle. Inflation also can eat into investment returns. Climbing interest rates often seen in an environment of rising inflation make it more expensive for people to pay their debts, buy a home or finance a loan to pay for a vacation or a child's education.

[Last modified June 28, 2006, 01:11:07]