This paper provides brief analysis of selected macroeconomical indicators of US economy and tries to sketch out possible future development of these variables. The main conclusion is that United States may be really threatened by possible inflation pressures in the future, as well as by possible pressures on its nominal exchange rate depreciation.Inflation; financial crisis; monetary aggregates; product

Bednarik, Radek

English

Research Papers in Economics

INFLATION IN THE US ECONOMY: IS IT A PROBLEM OR NOT? 
  
RADEK BEDNAŘÍK 
 
___________________________________________________________________________ 
 
Abstrakt 
Tento  článek  se  zabývá  stručnou  analýzou  vybraných  makroekonomických  ukazatelů 
ekonomiky Spojených států amerických a následně se snaží dovodit případný budoucí vývoj 
těchto veličin. Hlavním závěrem je skutečnost, že Spojeným státům může reálně hrozit riziko 
inflačních tlaků a tlaků na oslabení nominálního měnového kurzu. 
Klíčová slova 
Inflace, finanční krize, měnové agregáty, produkt. 
Abstract 
This paper provides brief analysis of selected macroeconomical indicators of US economy 
and tries to sketch out possible future development of these variables. The main conclusion is 
that United States may be really threatened by possible inflation pressures in the future, as 
well as by possible pressures on its nominal exchange rate depreciation. 
Key words 
Inflation, financial crisis, monetary aggregates, product. 
Advisor: doc. Ing. Luboš Komárek, Ph.D., MBA, MSc. 
Introduction 
It  is  known  and  generally  acknowledged  fact  nowadays,  that  the  last  (and  still  ongoing) 
financial  and  consequent  real  economy  crisis  is  crisis  of  mutual  trust  between  subjects 
engaging in financial markets
1. Commercial banks were too frightened to lend to each other 
and  the  liquidity,  that  very  important  factor  for  providing  loans  to  the  subjects  in  real 
economy sectors has dried up. Central banks all around the world have been trying to save 
what they can by pouring immense volumes of liquidity into literally frozen financial markets. 
In the course of history of Federal Reserve System (FED) is it “commonly” used tool for 
easing the stress of financial markets’ agents. Providing liquidity to ease the situation and to 
recover mutual liquidity lending between subjects was used to solve so-called Black Monday 
1987 event, when all financial markets all around the world literally crashed down. Liquidity-
pumping was used as some sort of cure and vaccination against possible panic in the situation 
                                                 
1 As Krugman (2007) states: „Behind the disappearance of liquidity lies a collapse of trust: market players don’t 
want to lend to each other, because they’re not sure they’ll be repaid. […] But what has really undermined trust 
is the fact that nobody knows where the financial toxic waste is buried. after the 11
th September attacks on the World Trade Center. This money-printing in order to 
help (or save) financial markets to overcome these shocks, of course, significantly helped in 
creating roots of financial crisis which erupted in the 2
nd half of the year 2007. 
In the United States and consequently in many economies in the Europe, government agencies 
were forced to provide financial help to some of most seriously affected financial institutions. 
These  efforts,  of  course,  didn’t  come  without  costs.  Enormous  extent  of  governments’ 
financial help caused large increase in deficit of fiscal (or public finances) budgets. It also 
seems quite likely, that this large quantity of money inserted into markets worldwide will 
result into serious inflation pressures. Thus, current economical recovery can be seen as weak 
and short-live one. 
In this paper, we want to do a brief check of the situation in United States and make a guess, 
whether “bad” scenario, in terms of (too) large fiscal deficits and high inflation, written above 
is likely to happen in this economy. 
Selected macroeconomic indicators and their development 
The  first  factor  we  want  to  look  at  here  is  so-called  real-potential  GDP  spread,  i.e.  the 
difference between real and potential gross domestic product – see Fig. 1. 
Fig. 1 Difference between real and potential GDP of US economy 
-600
-400
-200
0
200
400
600
-300
-200
-100
0
100
200
300
50 55 60 65 70 75 80 85 90 95 00 05
GDP_SPREAD (bil. USD)
GDP_SPREAD_HP (bil. USD)
Year
G
D
P
_
S
P
R
E
A
D
G
D
P
_
S
P
R
E
A
D
_
H
P
 
Quarterly  data,  seasonally  adjusted.  GDP_SPREAD  –  difference  between  real  and  potential  GDP. 
GDP_SPREAD_HP is GDP_SPREAD filtered by H – P filter. 
Source: FRED, own computations. 
Fig. 1 provides us with some interesting information. First, we can see, that in the past the gap 
showed strong cyclical pattern and for the most of the years in the time period 1974 to 1996 
the amount of real GDP was higher than its potential. Second, from the year 2001 there is another period of the real GDP overhang. This fact, and also the development of the indicator 
are not so surprising when we take into account the low-interest rate monetary policy of the 
FED. Even when financial crisis was ongoing there was, and still is, quite large and growing 
positive gap between real and potential GDP. This may bring us to maybe a little provocative 
statement  –  real  economy  crisis  is  simply  an  adjustment  of  economy  which  has  been 
overheated for a long time. The economy has been sustained in this “hot” state artificially by 
low primary interest rate monetary policy of FED. 
Now  we  can  turn  our  attention  to  another  important  factor  –  the  development  of  net 
government savings – see Fig. 2. 
Fig. 2 Net government savings 
-8%
-6%
-4%
-2%
0%
2%
4%
-800
-600
-400
-200
0
200
400
50 55 60 65 70 75 80 85 90 95 00 05
NGS/RGDP (%) NGS (bil. USD)
Year
N
G
S
/
R
G
D
P
N
G
S
 
Quarterly data, seasonally adjusted. NGS/RGDP is net government savings (NGS) to real GDP (RGDP) ratio, 
expressed in percents.  
Source: FRED, own computations. 
We can see that except for a rather short period of years 1997 – 2001, the federal government 
budgets were running deficits for a long-term period of time – from 1970 to present. The 
reasons behind these deficits are well known. In the eighties it was direct result of so-called 
“reaganomics” – income taxes cut-down and armament industry spending increment played 
the main role. Deficits running in the last decade have been tied with war-efforts spending. 
And the rather steep increasing of deficits in year 2008 – 2009 is direct effect of massive 
government help provided to financial (and real) sector of the economy. 
Just to illustrate the often stated fact, that the low interest rates monetary policy was the key 
factor behind all consequent financial and real economical difficulties, we show the Fig. 3 
displaying the development of the effective federal funds rate. Notice the development in the 
period of 2001 to present.  Fig. 3 Effective federal funds rate 
0%
5%
10%
15%
20%
25%
-5%
0%
5%
10%
15%
20%
55 60 65 70 75 80 85 90 95 00 05
FFR FFR_HP
Year
F
F
R
F
F
R
_
H
P
 
Daily data. FFR is effective federal funds rate. FFR_HP is FFR filtered by H – P filter. Shaded area covers 
period between 2
nd half of 2007 to present. 
Source: FRED, own computations. 
To  see  the  fact,  that  current  macroeconomic  policy  of  FED  provides  solid  grounding  for 
future inflation pressures take a look on the Fig. 4, which shows development and year-to-
year changes of monetary aggregate M1 and M2. 
Fig. 4 Monetary aggregates and their changes 
0
400
800
1,200
1,600
2,000
75 80 85 90 95 00 05
M1 Money Stock
-10
-5
0
5
10
15
20
75 80 85 90 95 00 05
CH_YTY_M1SL
0
2,000
4,000
6,000
8,000
10,000
75 80 85 90 95 00 05
M2 Money Stock
0
4
8
12
16
75 80 85 90 95 00 05
CH_YTY_M2SL
 Monthly data, seasonally adjusted. CH_YTY_[variable name] is year-to-year percent change of M1 and M2. M1 
and M2 are monetary aggregates, in billions of USD. Shaded area covers period between 2
nd half of 2007 to 
present. 
Source: FRED, own computations. 
Especially in the case of M1 we can clearly see the rather steep increase of money supply, 
which may result in severe inflation pressures in the future. 
To illustrate the unprecedented extent of liquidity injections provided by federal authorities 
see Fig. 5, which shows total borrowings of depository institutions from the Federal Reserve. 
We think that the Figure 5 is pretty self-explanatory. 
Fig. 5 Total borrowings of depository institutions from FED and their changes 
0
200
400
600
800
60 65 70 75 80 85 90 95 00 05
Total Borrowings of Depository Institutions from the FED
-1,000%
0%
1,000%
2,000%
3,000%
4,000%
5,000%
60 65 70 75 80 85 90 95 00 05
CH_MTM_BORROW
-50,000%
0%
50,000%
100,000%
150,000%
200,000%
250,000%
300,000%
60 65 70 75 80 85 90 95 00 05
CH_YTY_BORROW
 
Monthly  data,  seasonally  adjusted.  Total  borrowings  of  depository  institutions  are  in  billions  of  USD. 
CH_MTM_BORROW and CH_YTY_BORROW means month-to-month and year-to-year percent changes of 
the variable. Shaded area covers period between 2
nd half of 2007 to present. 
Source: FRED, own computations. 
As Fig. 5 suggests,  when financial  and consequent real economy crisis erupted, financial 
institutions  quite  quickly  came  under  the  serious  stress  and  need  for  additional  liquidity, 
which had to be provided by federal authorities, namely FED. Again, this massive liquidity 
injecting may bring serious inflation pressures in the future. 
Conclusion 
In this brief analysis of selected macroeconomic variables of United States economy we tried 
to analyze some aspects of the current complex and by no means quite difficult economical 
situation of this economy. 
We came to following conclusions. First, according to provided data the US economy seems 
to be still in “overheated” state. Gap between real and potential GDP is quite large and does not diminish. From this point of view, those efforts of federal authorities to revive and boost 
spending by providing cheap liquidity to financial institutions seems to be wrong and these 
efforts may result only in inflation pressures, in the long run. 
Second,  possible  future  inflation  pressures  are  indicated  also  by  rather  high  increment  of 
monetary aggregates, as indicated by Fig. 4. This development should not be surprising when 
one takes a look on the Figures 3 and 5. 
Third, federal budget deficits are quite deep and show no signs of declining. Here, the war-
efforts spending and financial help providing by federal government are to be blamed for this. 
Very possible high inflation pressures in the future and high fiscal deficits and consequent 
federal budget’s debt may endanger the stability and strength of nominal exchange rate of 
USD, mainly by lowering the confidence of foreign investors in US economy condition and 
future outlook. 
Literature 
[1]  ARLT,  J.  –  ARLTOVÁ,  M.  (2007):  Ekonomické  časové  řady.  1.  Vydání.  Grada 
Publishing, a.s., Praha, 2007. ISBN 978-80-247-1319-9. 
[2] GREENSPAN, A. (2007): The Age of Turbulence: Adventures in a New World. 1. vydání. 
Londýn, Allen Lane, 2007. 531 stran. ISBN 978-0-7139-9982-2. 
[3] KRUGMAN, P. (2007): Innovating Our Way to Financial Crisis. In: The New York Times. 
Dostupné na: http://www.nytimes.com/2007/12/03/opinion/03krugman.html?_r=2. 
[4] ECONOMIC RESEARCH OF FEDERAL RESERVE BANK OF ST. LOUIS: Economic 
Data – FRED. Dostupné na: http://research.stlouisfed.org/fred2/. 
 

Inflation in the US Economy: It Is a Problem or Not?

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