Friday, October 29, 2010

One more sign that deflation is history


The GDP deflator is the broadest measure of inflation, and with the release today of Q3 GDP statistics, we see that the deflator has been rising at just over a 2% annualized rate for the past two quarters. The deflator dipped into deflationary territory in Q4/08 (-1.2%) and again in Q4/09 (just barely, -0.3%), but it's been positive for the past three quarters. If we take recent Fed pronouncements at face value (i.e., inflation is unacceptable if it's less than 2%), then a 2% pace for the GDP deflator is close enough to perfection for government work. The time for stimulus has come and gone.

It's also very important to note that inflation has turned positive despite the fact that the economy remains far below its "full employment" level, with tons of "idle capacity." According to Phillips Curve dogma, which permeates Fed thinking, this is not supposed to happen. With the economy suffering from so much "slack," inflation pressures should be virtually nonexistent or most likely negative. This is the thinking that has propelled the Fed to the cusp of QE2: they feel they have to pump up demand or face some serious deflation. Well, so far it's not working out that way. That's one more reason why QE2 is unnecessary—the Phillips Curve theory does not adequately explain how inflation works.

5 comments:

Bill said...

Wouldn't GDP have to jump significantly Q4 for your prediction of 3-4% 2010 GDP growth to come true? Doesn't seem likely.

Scott Grannis said...

I will address this in greater detail later today, but for now let me say that year over year growth in GDP was 3.0% as of Q2/10, and 3.1% as of Q3/10. I think that fits right in with my forecast (first made in Dec. '09) that the economy would hit bottom in mid-2009 and grow at a 3-4% rate for the foreseeable future, and that growth would be insufficient to cause a meaningful decline in the unemployment rate.

I think focusing on quarterly growth rates is an exercise in futility; it makes much more sense to look at growth on a multi-quarter or yearly basis.

marmico said...

Go back to GDP arithmetic school Grannis.

The GDP deflator tends to increase when export and final domestic expenditure prices are increasing relative to import prices, such as the 3 doors in the following scenarios:

1. Export and final domestic expenditure prices are increasing sharply, and the price of imports is increasing only slightly;

2. Export and final domestic expenditure prices are increasing slightly, and the price of imports is decreasing;

3. Export and final domestic expenditure prices are decreasing slightly, and the price of imports is decreasing sharply.

Take door number 2. Pay attention to someone down the Pacific Coast Highway who has forgotten more about the arithmetic than you'll ever know.

Well Bill, that unintended inventory accumulation juicing Q3 GDP is gonna bite real hard in Q4. In any event, it's only the first go round and there will be subsequent revisions.

Pragmatic said...

"I think that fits right in with my forecast (first made in Dec. '09) that the economy would hit bottom in mid-2009 and grow at a 3-4% rate for the foreseeable future"

Using your date of Dec. 2009, let's see if the first full year's GDP growth after your forecast will be above 3%. The first 3 quarters of 2010 have seen GDP growth at 3.7%, 1.7%, and 2%. In order for it to hit the 3% annual rate in the first 4 quarters since Dec. 2009, the 4th quarter GDP growth has to be 4.5%.

Scott Grannis said...

oops, the forecast I'm referring to was made in Dec. '08, not '09