Lastly, when inflation does return:
5. How high will inflation go?
Given the high level of slack likely to remain in the economy during the next two years, there could actually be some deflationary pressures that linger in the system. For example, unemployment isn’t expected to peak until 2010 at over 10%. Industrial capacity utilization rates are at their lowest levels ever, which means a lot of unused capacity in the manufacturing sector. This slack must be cinched up before upward pressure is put on wages and other prices. Double-digit inflation outbursts remain unlikely in the short to medium term.
However, in economies where there is less slack, i.e. China and India, prices could rise more quickly. Commodity prices have been driven more from emerging economies than wage growth in the U.S. In mid 2008, CPI hit 5.4% driven mainly by commodity price spikes despite the fact the U.S. economy had been in a recession for 6 months at that point.
BOTTOMLINE ANSWER: If the Fed is not quick enough to withdraw liquidity as money velocity picks up, prices are likely to rise. Rampant inflation may not occur if the U.S. remains below its potential growth rate.
Source: MARE group