Friday, December 12, 2008

Producer Price Inflation not dead

Producer prices fell by 2% in November, leaving the year over year change at a very modest 0.4%. But most of the decline in this measure of inflation was the result of collapsing oil prices. Leaving out food and energy prices, "core" PPI inflation was 0.1% for the month, and 4.2% for the past year.

As this chart shows, we've seen huge swings in inflation in recent years, all of which were driven by very volatile energy prices. Taking out energy, we see a consistent trend in core inflation, which has been slowly but steadily rising. Energy prices don't cause inflation, monetary policy does. Given their extreme volatility in recent years, it makes sense to focus on core inflation. And doing so tells us that inflation is still very much alive and well. And with the Fed being orders of magnitude more accommodative today than ever before, I think it's way too premature to pronounce inflation dead, as the bond market appears to be doing. Beware the very low yields on Treasuries, and be alert to the opportunities in TIPS.


dave said...

With the little yellow metal at over $800 an ounce( more than double it's average price of $350 through out the 90's)there is still plenty of inflation baked into the economic cake.The only thing masking it is the contraction in the global economy.
The Fed is going to be lost when the velocity of money picks up as they have no real frame work to guide them in determining how to withdraw the overabundance of dollars in the system.
Our old friend from Morristown NJ would be beside himself if he were still with us.

Scott Grannis said...

I have to agree with you that gold is telling us there's more inflation out there. The only question in my mind is how much of gold's price represents a premium for safety in a world of currencies whose values suddenly appear to be questionable, and how much represents a higher price level. Still, to believe the Fed can act to perfection when withdrawing all they have added is to believe in the tooth fairy. That's why I think the bond market is really off base in calling for an extended deflation.