If the Fed would discard its Phillips curve and embrace inflation-sensitive market prices as a policy guide, then the fed funds rate could drop a percentage point in the next few months without endangering the goal of domestic price stability. The virtual absence of inflation is a big plus for the future economy. Big inflation increases create an economywide tax hike effect, reducing the usefulness and buying power of money. It's a tax hike on money. Big interest rate increases resulting from inflation turn off the credit spigots, raise financing costs, reduce investment demands, and compress stock market multiples.
Inflation is the most powerful recession-inducer.
But the absence of inflation today leaves the economy more resilient and flexible than in past cycles. The probability of this is exceedingly remote. Also, rapid innovation rates, including more powerful bandwidth, and numerous wireless appliances connected to the Internet, and rapid diffusion rates, i.e., the mass consumerization of information tech and its applications, will continue to thrust the economy fast-forward. Low inflation, King dollar and the technology-induced productivity rise act as shock absorbers to cushion the impact of things like temporary energy price hikes, Y2K transition, or even Fed tightening actions. But there are, however, two other prosperity threats that must be addressed if we are to maximize our economic growth.