One of the surprising things over the last 10-15 years is that, in spite of a fast paced economy, inflation was never a problem. Consumers were spending like sailors on shore leave and all were buying their dream home. We should have seen demand driven inflation but we did not. This would suggest that in today’s world inflation is the result of “cost push,” and not “demand pull.” In other words inflation now is caused by increases in the cost of labor, materials, transportation and the other elements involved in getting the product or service to the market. Evidence of this was that the runaway increase in the cost of oil last year did push inflation up a bit. But by and large we have been thankfully spared this problem. Even now with massive injections of Federal funds into the economy via the TARP and the stimulus plan, we see almost no inflation.

I submit that perhaps the real cause of inflation is the cost of credit. You may be surprised to know that unemployment was even higher in 1981 than it is today. But unlike now, unemployment then was accompanied by high inflation. To combat inflation then Federal Reserve Bank Chairman Paul Volcker raised the Fed’s rate to the point that we had double digit interest rates for loans. When the economy was on the verge of expiring in 1982, Volcker finally dropped the Fed rate in November of that year and recovery began. I suggested then that perhaps the real reason for inflation was the cost of borrowing, rather than the pull of demand or the push of other costs.

Fast forward to today. Again, we have had high rates of growth in demand over the last decade or so, but little inflation. That high rate of growth in demand has been fed by relatively cheap credit. I am once more intrigued by the relationship of the cost of credit to inflation. This time low credit cost is present while inflation is low, in contrast to the high cost of credit being present during the high inflation of 1980.

Regardless of my academic interest in this relationship, and perhaps a necessary revisision of our understanding of inflation, the low inflation rate now is allowing the present Fed Chairman Ben Bernanke to keep the cost of credit low. However, it will be interesting to see if inflation responds more to the hoped for resurgence in consumer demand, or the expected future increases in credit cost.