CHICAGO Jan 19 Inflation is unlikely to be a problem as long as U.S. unemployment remains elevated, according to economists from the San Francisco Federal Reserve Bank.
In the San Francisco Fed's latest Economic Letter released on Tuesday, economists found high joblessness has helped subdue inflation since the recession began in late 2007, bolstering the case for an employment-inflation link that some policy makers dispute.
"Our findings suggest that the high level of the unemployment rate over the past year likely contributed to the substantial declines in the inflation rate," economists Zheng Liu and Glenn Rudebusch said.
While inflation and unemployment don't "line up" well in milder recessions, they have moved together during the current deep downturn, the economists said.
The Fed slashed benchmark overnight interest rates to near zero percent in December 2008 and has said it will keep rates low for an extended period to boost economic recovery.
A central element of debate with the Fed's rate-setting committee is whether a decline in the national jobless rate, now at 10 percent, would need to be seen before changing the stance on rates. Evidence of a strong link between high unemployment and low inflation could bolster some policy makers' arguments for keeping interest rates low for a longer period.
San Francisco Fed President Janet Yellen, who does not have a vote on the U.S. central bank's policy-setting Federal Open Market Committee this year, is considered one of the more "dovish" officials seen as leaning toward not raising rates.
While many officials share the view that inflation is unlikely to ignite until unemployment recedes, some worry that the more than $1 trillion the central bank has pumped into the economy could spark inflation before then.
The San Francisco Fed economists said their findings should be interpreted with caution and that inflation could rise even before the jobless rate comes down.
"Other factors determine inflation beside the unemployment gap," they said. "For example, supply shocks and commodity price increases can push inflation up."
That's what happened in the 1970s, the economists said, adding that had been an "important and painful lesson."
Expectations on inflation can also be a key driver of actual inflation, they said.
But those expectations remain low, despite the expanded size of the central bank's balance sheet, since the Fed's commitment to maintaining price stability is seen by market participants as credible, the economists said.
Maintaining the Fed's independence is crucial to keeping that credibility, they added.