An Urban's Rural View

Taking Inflation Seriously

Urban C Lehner
By  Urban C Lehner , Editor Emeritus
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Inflation has been tame in recent years -- so tame that many have forgotten how nasty inflation can get when untamed. Younger farmers and ranchers have no experience with that. Their parents and grandparents remember the high-inflation world of the 1970s and early '80s all too well -- the double-digit interest rates, the soaring input costs, the government's futile efforts to keep wages and prices from spiraling out of control.

Could it happen again? With the economy strengthening, inflation picked up last month, though not dramatically. Core inflation, which excludes volatile food and energy prices, exceeded the Federal Reserve's 2% target on an annual basis.

No one is yet forecasting a rerun of the '70s, but long-term interest rates have been rising, indicating investors are anticipating higher inflation. Markets aren't panicking, but they're starting to pay attention. So should farmers.

Low inflation and slow economic growth are the major reasons central banks have been able to keep short-term interest rates so low for so long. In recent years central banks around the world have been trying to push inflation up to what they regard as a safe 2% to 3% rate -- and undershooting that target. Some of them have worried more about deflation than inflation.

A year of global economic growth has put deflation fears to rest. Slowly but surely central banks in developed countries have been raising short-term interest rates and reining in their market-propping, bond-buying "quantitative easing" programs. Until recently long-term rates, which are set by the markets, have gone up more slowly, suggesting investors aren't overly concerned about inflation. But in the last few weeks the yield on the benchmark 10-year Treasury note has climbed above 2.5% for the first time in 10 months.

Is the bond market crying wolf? It's done that before, but Harvard economist Martin Feldstein, who chaired President Ronald Reagan's Council of Economic Advisors, thinks this time it's for real. In a Wall Street Journal op-ed piece, he sketched four reasons why the bond market will keep pushing long-term rates higher (…).

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-- As the Federal Reserve raises short-term rates, which it says it will do three times in 2018, the markets will naturally follow suit.

-- As the Fed dumps its holdings of the bonds it acquired in quantitative easing, there will be more bonds on the market, dragging bond prices down. The first rule of bonds is that as bond prices decline, yields rise.

-- To finance the deficit, the federal government will borrow another $700 billion this year, increasing the supply of bonds still further.

-- Easy monetary policy has produced an "overly tight labor market," and as a result, "there is an increased risk that at some point inflation will shoot upward." Inflation chips away at the purchasing power of interest payments, causing interest rates to rise in compensation.

It's hard to argue with Feldstein's first three points. Less hawkish economists will disagree with him on the fourth, the risk of inflation shooting upward. So far, the markets aren't pricing in that risk. Should they come around to Feldstein's view, watch out. For as Feldstein notes, "The expectation of rapid inflation will cause long-term rates to rise even before that faster inflation occurs."

What inflation doves ignore is how fast inflation can spin out of control -- and how hard it is to escape the self-reinforcing feedback loop in which high inflation begets high-inflation expectations which beget even higher inflation. I saw that covering economics for The Wall Street Journal during the '70s. At one point, I reported on the front page that economists were expecting only 6% inflation in the year ahead.

I was, justly, criticized for that "only," implying that 6% wasn't such a bad inflation rate. But it was, in fact, an improvement over where inflation had been. In the end, it took a few years of 20% interest rates to squeeze the inflation out of the economy. The collateral damage of those rates -- negative economic growth, lost jobs, bankrupt farms -- was extraordinarily painful.

It's hard to get people who haven't lived through times like those to grasp that inflation is not to be toyed with. Recently inflation has been so tame that some economists have even urged central banks to raise their inflation targets to 4% or more to goose economic growth. You have to wonder if these economists have given any thought to how difficult it would be to stamp out inflationary psychology and restrain inflation at "only" 4%.

One developed country that takes inflation seriously is Germany. Little wonder, that. The Germans have long memories of the hyperinflation that wreaked havoc on their ancestors in the early 1920s. In 1923, the exchange rate hit a trillion marks to the dollar. A wheelbarrow full of money wasn't enough to cover the price of a newspaper. People cashed life-insurance policies to buy a cup of coffee (…).

As a result, German central bankers are legendarily famous for their aversion to running even the slightest risk of inflation. Foreign economists criticize them for taking this aversion too far. Still, everyone understands where they're coming from.

The U.S., thankfully, has never experienced hyperinflation. The '70s and early '80s were as bad a bout of inflation as we've been through. It was bad enough. Anyone who remembers it won't want to live through it again.

Urban Lehner can be reached at


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