Disinflation (inflation going lower) or outright deflation (prices falling) seem to be the bigger threat over the next 2-4 years.
Basically, when a society is so indebted that everyone must save more, consume less, and pay off debt, deflation is a bigger risk than inflation. Much of the Western World is in that situation.
In the US, the money supply is a key leading indicator for potential inflation or deflation. The Fed, for various reasons, no longer publishes M3, a broad definition of the money supply. It stopped in 2005, as the bubble took off.
For more on the money supply, see: http://en.wikipedia.org/wiki/Money_supply
For more on why the Fed stopped publishing M3, see their two explanations:
However, private sector companies that calculate/estimate economic figures(Capital Economics and ShadowStats) suggest that M3 has contracted since June 2009, by about 5.4% over the last year (June 2009 to June 2010).
Private Sector Forecasters Show M3 (A Broad Money Supply Indicator) is Falling
It looks like the Fed is taking a page out of the failed BOJ deflation playbook out of the last 20 years, despite Bernanke’s speech suggesting the contrary: Bernanke's Speech in 2002 after the DotCom Bust's Deflation Scare
The more thoughtful members of the Fed Board think deflation and a slowing economy are a much bigger risk than high inflation and an overheated rebound. The President of the Boston Fed said today:
“The core inflation rate is right around 1%. Given the amount of substantial excess capacity that we have in the economy, there is some risk of further disinflation. And I would say the risk of deflation has gone up and is more of a risk than I would like to see at this point.
“We’re seeing core prices continuing to decline in Japan. We’re seeing some of the peripheral [European] countries like Ireland starting to see actual declines in prices as a result in part of a fiscal austerity. We have a number of other countries in Europe that are about to embark on a substantial fiscal austerity. We don’t want to be in a situation where countries other than Japan start worrying about deflation.
“We have plenty of tools to tighten up if it turns out the economy grows faster and inflation becomes more of a concern. But it is a little uncertain how effective our tools are once the economy gets into a deflationary environment. The experience of Japan is sobering. They’ve spent a decade and a half dealing with an economy that has had falling prices and despite a variety of monetary and fiscal actions taken are still facing a deflation problem.
“It just highlights that it is not straightforward for policy makers to break out of a deflationary environment. And so if you were to look at the balance of risks and what we could do about those risks, the risk from a downside shock I would view as more of a problem than the risk of an upside shock of inflation or to the economy overall.”
See the whole interview (very informative) at the WSJ Blog here: Full Boston Fed Rosengren Interview.
Again, if the money supply keeps contracting at this rate, it eventually has to lead to deflation, which can be a trap once it gets anchored into consumer expectations.