Tuesday, August 17, 2010

No sign of deflation at the producer level

There's not even a hint of deflation in the producer price indices. The core index, in fact, is up at a 2% annual rate over the past six months, and at a 2.6% rate in the past four months.

Important reminder: given the still huge amount of "idle capacity" in the economy (e.g., the economy as a whole is operating at about 10% less than it could be if we were at "full employment), the conventional theory of inflation is being sharply repudiated by these numbers. We should be seeing clear signs of deflation if the conventional view were correct, but we're not. That's because inflation is a monetary phenomenon, and it only occurs when money is in excess supply. We know that money is in excess supply these days because: the dollar is very weak relative to other currencies, gold and commodity prices are rising, the yield curve is still quite steep, inflation expectations are positive, and real interest rates are low or negative. And don't forget that the Fed has pledged with its heart and soul to avoid a deflationary outcome, and they have backed up their words with over a trillion dollars of money creation. In my experience, one should never doubt that the Fed will achieve its stated goals.

I'm nothing short of flabbergasted at the persistence of the belief that we are at risk of falling into a deflation, when all the important monetary indicators are all pointing in the opposite direction.


Benjamin said...

Well, this is an excellent post by Scott, and citing anecdotes might work for Reagan, but doesn't cut ice with this crowd...still, I just know of many deals in which non-price breaks are being granted.

Example, an industrial landlord (me!) recently built a ceiling exhaust fan free for a prospective tenant. Rents are down anyway, but this was icing on the cake, that might not show up PPI ststs.

These kinds of deal-sweetners are common today for anybody selling anything.

With reported inflation near zero, such sweetners could be shoving the real prices into negative territories.

jfknapp3 said...

Conventionally, inflation would only rear its head when the "too much money" in the economy begins chasing "too few goods." Currently it appears consumers are in no mood to spend, which means the goods aren't being chased. Meanwhile the excess money supply isn't being turned loose to chase anything, it is being used to pay down consumer debt, stuffed in mattresses or hoarded by banks (to prepare their balance sheets for...?).
Wouldn't this type of behavior (at least potentially) indicate a deflationary atmosphere?

Scott Grannis said...

You can't think about supply and demand in isolation. You have to think in "relative" space. The forces of supply and demand converge at a price. If the price is falling, then supply must be exceeding demand. Look at the price of money and you see it is falling (e.g., a weak dollar, rising gold). That tells you there is an excess of money relative to supply. That is where the demand that chases goods comes from.

Deleveraging is ongoing, but that just means that the demand for money is unusually strong. The Fed has met that demand, however, and exceeded it, by being willing to supply an almost infinite amount of money at almost a zero interest rate.