Confusion on inflation

Several days ago, I attended a meeting with the Chief Strategist of BCA Research, an independent research house, to discuss key issues in the economic and financial outlook.  The biggest debate between the audience and the speaker was about inflation. 

Based on BCA, there are three mechanisms that drive inflation: (1) monetarism - too much money chasing too few goods, (2) cost-push - rising input prices force companies to raise prices and (3) demand-pull - an economy growing strongly will give companies more pricing power and workers more wage bargaining power.  But BCA does not think the U.S. has an inflation problem (at least for near-term), and pointed out the evidence of subdue broad money (M2) growth and bank lending growth, small impact of rising food and commodity prices on final output prices, and the slack and high unemployment rate in the economy is preventing wages from rising, which means with rising food and commodity prices, workers are cutting back on other spending items as workers cannot demand higher wages.

The U.S. Federal Reserve (Fed) focuses on core inflation (consumer price index stripping away the more volatile components of food and energy) as a better predictor of future headline inflation.  Core inflation averages about 1.5% in Q1 2011, lower than the 2% target of the Fed. This has invited lots of criticisms as if the Fed presidents do not eat or do not drive as rising food and commodity prices are clearly eating deeper into consumer's income and headline inflation is rising towards 3%.

The Atlanta Fed president, Dennis Lockhart, did make an important point about inflation confusion in his February speech:

"Let's review what inflation is and is not. Inflation affects all prices. Inflation is not the rise of individual prices or the rise of categories of prices.
"I want to contrast inflation to the cost of living. In casual language, we often interpret a rise in the cost of living as inflation. They are not the same thing. Cost-of-living increases are a result of increases in individual prices relative to other prices and especially relative to income. These relative price movements reflect supply and demand conditions and idiosyncratic influences in the various markets for goods and services. If some component of a household's cost-of-living basket goes up in price, the higher cost of living is not ipso facto inflation."

Since the Fed cannot control cost of living or the movement of individual prices, "so monetary policy is not about preventing relative price adjustments dictated by market forces. It is about controlling the broad direction and pace of change of all prices across the economy."

Given the U.S. Fed is targeting both stable prices and high employment, and they believe commodity and food inflation are temporary, and that the economic growth is not bringing up job growth, US Fed Funds rate will remain low in the foreseeable future, at least this year, even with QE2 ending.   Clearly inflation pressure (caused by monetary, cost-push and demand-pull factors) in the emerging countries of China, Brazil etc. are much more serious.  With fundamentals continuing to be favorable for commodities, it is not surprising to see the policy maker starting to be more serious in using currency to fight inflation e.g. faster rising Chinese Renminbi.