The Fed’s meeting minutes got the stock and bond markets all excited today based on the staff’s analysis that inflation wasn’t a problem. The markets interpreted this to mean that rate rises would continue the steady 1/4 point per meeting pace for a while, and then stop at some nirvana point.

Inflation isn’t a problem because wages aren’t going up and the measurements are biased. Competition from overseas, both in direct terms and in outsourcing, has flattened wages. The price indices the Fed uses don’t include financial assets and housing (because equivalent rents are used, not the price of houses), and typically they also eliminate “volatile” food and energy. To squeeze any hint of price increases out of the rest, “hedonic adjustments” and “substitution adjustments” are used. These deflate price increases by supposed improvements in quality or by, for example, substituting hamburger for steak in the index if steak gets too expensive.. Inflation measured in this way is not going to be a problem.

Leaving aside the measurement distortions, the labor demand isn’t there to ignite a wage/price spiral. Instead, the consumer will be gradually squeezed to death between flat or declining incomes and higher prices for food, energy and housing.

The Fed could raise interest rates to rein in these costs. But it won’t because it knows that to do so would quickly topple the financial markets. By maintaing the present “measured” pace, the Fed will allow the unmeasured inflation to grow unchecked, leading to a future collapse of demand and pricking of the credit bubble. But Uncle Al hopes that will be on someone else’s watch. Poor Ben. He has mentioned dropping money from helicopters in order to counter deflation. He’s better get his fleet together.