Zeroflation: the US achieves price stability

The latest CPI has come out (here pdf 98.1kb) and it shows a monthly increase in inflation of just 0.3%.

The year on year inflation figure is 0%.

Of course, the reason why inflation has suddenly dropped from high to zero is because the economy has contracted and loads of people are out of work.

Nevertheless, I would argue that keeping the price of money stable is essential for any sort of recovery to occur. John Maynard Keynes says this in A Tract on Monetary Reform:

[The economy] cannot work properly if the money... assume[d] as a stable measuring rod, is undependable. Unemployment, the precarious life of the worker, the disappointment of expectation, the sudden loss of savings, the excessive windfalls to individuals, the speculator, the profiteer--all proceed, in large measure, from the instability of the standard of value.

It is often supposed that the costs of production are threefold... labor, enterprise, and accumulation. But there is a fourth cost, namely, risk; and the reward of risk-bearing is one of the heaviest, and perhaps the most avoidable, burden on production....[T]he adoption by this country and the world at large of sound monetary principles, would diminish the wastes of Risk, which consume at present too much of our estate.

In other words, when the price of money is stable, the "wastes of risk" are lowered.

Remember, money functions in the following way:

1. As a way of measuring the worth of goods and services.
2. As a means of exchange for these goods and services.
3. As a commodity that is bought and sold.

In order for 1. to work effectively, the value of money must remain the same. In order for 3. to work alongside 1., the money supply must be expanded or contracted according to demand. If the demand for money drops, so should supply. If the demand for money increases, so should supply.

Normally, 1. is not utilised properly. Markets will naturally use money as a way to determine worth, but if the value of money keeps changing (either through inflation or deflation) the market is more likely to make mistakes in investing, borrowing, producing and consuming.

Now that "zeroflation" has been achieved, it is important for the Federal Reserve to adjust interest rates upwards in case of inflation, or to inject more money into the economy in case of deflation. So long as the long term inflation rate is zero (and neither negative or positive), the occasional monthly foray into deflation or inflation can be sustained.

Will the Fed do this? Highly unlikely.