The latest consumer price inflation numbers came out for February.  The year-over-year CPI now stands at 2.2%, while the year-over-year median CPI stands at 2.4%.

While consumer price inflation has picked up a little in recent months (with a significant 0.5% in January), overall consumer price increases have remained fairly steady.  Of course, if the dollar is depreciating at 2% per year, we shouldn’t just accept this, as it still makes us poorer than we otherwise would have been.  And the CPI numbers do not take into account the full damage done by previous monetary inflation in misallocating resources.

Still, relatively speaking in our modern-day central bank world, 2% consumer price inflation is low.  The Fed is right around its benchmark.  This enables the Fed to very gradually reduce its balance sheet and raise its target federal funds rate.  At the same time, the Fed doesn’t have to rush into it and risk spooking markets too much.

It is amazing how much of a free pass the Fed has gotten over the last decade.  It engaged in massive monetary inflation with QE1, QE2, and QE3.  It multiplied the adjusted monetary base by a factor of almost 5, yet we have not had the corresponding consumer price inflation (not counting health insurance).

No matter what the Fed has done, the CPI has stayed within a relatively narrow range.  And even interest rates have remained in a relatively tight (and low) range.

Federal Reserve officials have had the luxury of something like a Goldilocks economy.  While wage growth and GDP has certainly been slower than what most would prefer, at least they can point to a little wage growth and low unemployment rates.  And at least the GDP is in positive territory.  Despite the struggles of the American middle class, the statistics tell them that they are doing just fine.

Based on the government statistics though, it really is a Goldilocks economy.  It isn’t too hot, and it isn’t too cold.  Price inflation is low, but positive, which is what the Fed wants.

The problem for the Fed (which is no longer Janet Yellen’s problem) is that this can’t last forever.  This “not too hot, not too cold” scenario is going to end.  It has to end at some point.

The reason it has to end is because of the previous malinvestment.  The money creation from 2008 to 2014, coupled with artificially low interest rates, has misallocated resources.  When it is realized that resources are not being allocated in accordance with consumer demand, then there is going to be a correction.

The Fed can allow the correction to happen (the best choice), but that would be painful, even though it is the better long-term solution.  The Fed can try to stop the correction, or at least ease the pain, by creating more money out of thin air.

I don’t believe in the Keynesian theory that there is a trade-off between inflation and economic growth, or a trade-off between inflation and employment.  The 1970s already proved the Keynesians wrong with high price inflation and recession.

Still, I think in the short run, there can be a trade-off.  If the Fed engages in massive monetary inflation, this can certainly help to mask some of the problems and give a short-term boom.

Right now, the Fed is walking on a balance beam.  If it leans too far to the right, it gets a recession.  If it leans too far to the left, it gets higher price inflation.  The Fed is always walking on this balance beam in a sense.  The problem is that, with the previous misallocations, the Fed is running out of beam to walk on.  It is narrowing and becoming more like a tightrope.  (Richard Maybury has used a similar analogy.)

The Fed will eventually be faced with a scenario of a correction or a return to money creation.  And even if it turns to money creation, it may not be enough, as it would likely only resort to this if we are already in a recession.

Some might ask why the Fed can’t just keep printing digital money forever to keep the boom going forever.  But even here, it can’t last forever.  We would eventually have runaway price inflation.  As Mises said, we would end up with a crack-up boom, which isn’t really a boom at all.  It is hyperinflation, which in itself is far worse than anything a regular recession or depression could give us.

To be sure, it would be possible to have an economy where we have low (or no) price inflation coupled with economic growth that goes on and on.  That would be true prosperity.  That can only take place in a free market economy.  If there is constant manipulation of the money supply and interest rates, there are going to be unsustainable bubbles that form.

It might be technically possible to get out of our current mess if we had a quick turn to the free market, coupled with some life-changing technological innovations.  The good forces of prosperity would have to overwhelm the correction or realignment of resources.  But given the extent of the previous monetary inflation, and given that the federal government is consuming over $4 trillion per year, this is not at all likely.

In conclusion, just because the Fed has been humming along with its Goldilocks economy, it doesn’t mean it will last forever.  Stock investors have already shown signs of fear, as volatility has picked up considerably.  Remember that the Fed’s balance beam will eventually run out, and the Fed will fall to one side or the other.  It will bring the rest of us down for a ride.