The US Federal Reserve has kept interest rates unchanged amid signs that the world’s largest economy is still some distance away from embarking on a sustained high growth trajectory. Inflation, or the rate of economy-wide price movements, remains one of the most fundamental metrics to gauge which way the tide is turning.
The laws of demand and supply are central to understanding inflation dynamics. For instance, if goods are disappearing at a faster clip from shop shelves it would primarily be because people are spending more. Household expenditure patterns are a function of income. Bigger salary increases during a certain period compared to a previous time would result in more spending. This can push up inflation rates.
Look around you: Are your neighbours dining out more, are people buying newer cars and gadgets, are families spending more on vacations? Households spending more are early signals for the onset of an economy-wide revival. But, the clearest indications, of course, are available in the job market.
On Wednesday, when the US Federal Reserve held interest rates steady, it did so on the basis of movements in these basic metrics: Inflation and jobs. Fed Chair Janet Yellen told a news conference that “caution is appropriate” when it comes to raising interest rates. She said she was not convinced underlying inflation had accelerated.
That said, the Fed continues to keep one eye firmly on the developments in the world economy. Global economic and financial developments continue to pose risks and will likely keep inflation low for the remainder of 2016. Price movements in non-food non-energy articles or what economists call “core” inflation is the primary gauge for disposable income and demand-driven inflation.
The Fed wants this inflation to rise and firm up at a higher level to be doubly sure that the economy is creating more jobs, raising people’s income and leading to greater spending. Yellen said it remained to be seen whether a recent firming in US core inflation would be sustained. The implied meaning of this rather “dovish” stance could be that the world economy may remain shaky in the coming quarters. India’s policy makers should take note.