Thursday, October 16, 2014

Still no signs of deflation

Fears of deflation are all the rage these days. Phrases like this can be found everywhere: Europe is "perilously close" to deflation, major economies face the "specter" of deflation, Eurozone "deflation threat" looms, the clear and present "danger" of deflation, the risk of deflation fuels global fears, etc.

It's completely overblown. Deflation is not like a black hole that sucks economies in once they cross the zero price change event horizon. Just because Europe's CPI increase is approaching zero doesn't mean the Eurozone economy is going to collapse or that something urgent needs to be done. Japan's problems over the years are commonly attributed to deflation, but that ignores completely the fact that Japan's fiscal policies have been abysmally bad for decades (e.g., way too much government spending). Deflation doesn't necessarily lead to recession or even slow growth. The U.S. economy boomed in the late 19th Century despite years (or actually because of) years of deflation; falling prices dramatically increased consumers' purchasing power and fueled a huge rise in living standards. Deflation is often necessary for an economy to adjust to external shocks.

In any event, although a decline in producer prices in September captured the headlines yesterday, there is no evidence at all that producer prices are falling. Producer prices are notoriously volatile from month to month, and the often decline in one month only to rise the next month. As the chart above shows, over the past year producer prices are up 2%, and they are probably trending higher at a 1.5% annual rate.

Take out falling energy prices, and you find that core producer prices—shown in the chart above—show absolutely no sign of declining.

Forget about the deflation bogeyman. Deflation is not a threat and it's not happening in any event.


Joseph Constable said...

Here it is again. 2% inflation is the magical number. 1.5% inflation is bad. FED president Bullard in the WSJ -

He expects 3% growth in the second half but damn it inflation is too low. “Inflation expectations are dropping in the U.S., and that is something that a central bank cannot abide,” Mr. Bullard said. Me sarcastically: If only we could get to 2% everything would be wonderful.

Maybe the FED needs to be added to serious downside risk to the economy.

Scott Grannis said...

This obsession with avoiding inflation below 2% is indeed troubling. As a consumer and an investor I would much prefer zero to 2%. Stable prices are nirvana in my book.

And in any event, the Fed does not have the ability or the smarts to fine-tune inflation to such a degree.

William said...

Ebola Non-Sense: 3 patients successfully treated at Emory and Nebraska Hospitals without problems

Two patients infected in Africa with Ebola virus were successfully treated at Emory University Hospital and one in Nebraska without any secondary infections. Only the Dallas Presbyterian Hospital has had a very poor performance: first is not admitting and isolating the black African man who developed Ebola on a visit to the USA who presented with a fever of 103+ degrees and second in not properly training its medical and nursing staff in how to use the protective equipment. In particular, in how not to contaminate themselves when they removed their gloves and gowns.

None of the family or other intimate contacts of the first black man from Africa living in the same Texas home have been infected!! Ebola is NOT an “airborne disease” and not transmitted like the flu. To be infected, one must be in contact with the Ebola patient’s fluids i. e. vomit or feces from diarrhea.

The TV and media coverage has been hysterical AS has been some of the misinformed politicians’ comments. There is no reason to panic!!

Doctors Without Borders {Medicins Sans Frontieres} has been treating Ebola patients under extremely primitive conditions and their personnel have NOT become infected even though Ebola virus is literally all around them BECAUSE THEY UNDERSTAND HOW TO USE THE PROTECTIVE EQUIPMENT AND HOW TO TAKE IT OFF WITHOUT INFECTING THEMSELVES.

William McKibbin said...

Here are a dozen charts that purport to show the "permanent damage" endured by the US economy since 2000...

Benjamin Cole said...

Japan should have balanced their federal budget, but it was monetary policy that drove down their economy for 20 years while that yen exploded in value. Most people consider federal deficits to be inflationary---but the Bank of Japan kept money so tight that Japan managed to obtain deflation anyway.

And it is not clear that a modern economy can escape from zero lower bound. So far Japan has not managed to escape zero lower bound while Europe is drifting closer and closer to zero lower bound.

John Cochran suggests converting the entire national debt into bank reserves through quantitative easing. That may be a good idea.

Hans said...

Mr Grannis, EuroLand has more problems to worry about than deflation; although
your reasoning are very sound.

The state of economic malaise in Europe can not be underscored; as most members of the Common Market continue to struggle economically.

Regarding Bola, hear is the plight of Doc Without Borders:

Mark said...

Great article - educational for me

Thank you - I have been watching my EuroStoxx50 take a hammering on recession and deflation fears. Maybe I can relax a little

Benjamin Cole said...

— French 10-year government bond: 1.13%
— German 10-year government bond: 0.75%
— Japanese 10-year government bond: 0.48%

Institutional investors are giving their money away for 10 years---is this not a sign of deflation?

Besides, measures of inflation are only estimates, and change depending how you measure housing (always tricky) or technological and medical improvements. Your smartphone is worth how much in 1980 dollars? How about new medical device that saves your life? If you order a product over the Internet for a $4 shipping fee (Amazon), and it saves you a two-hour shopping trip, how much is that $4 worth?

Especially over a longer period of time, an inflation index becomes less and less meaningful.

Thus, it is correct, that to obsess with a particular rate as measured, say 0% or 2% is a bit silly.

Better to pursue robust economic growth, through regulatory, fiscal and monetary policies, and shoot for inflation band, such a 2% to 3% as does the Reserve Bank of Australia.

Israel shoots for 1% to 3% inflation. China is undershooting its target of 4%, which may be a ceiling.

Given the way that inflation is measured, getting to 0% seems to result in stagnation, ala Japan. It also results in evisceration of property and equity values, at least for the first 15 years or so. I would prefer to avoid that option.

It may be that 2% inflation, as officially measured, is really about 0% inflation, given the incredible advancements being made in technology and medicine, and new retailing.

Remember, the U.S. altered the way it measured inflation several years back, and that lowered the reported inflation rates by a few percentage points. I think the new method is more accurate, but perhaps it is aging also, and becoming less accurate.

The important thing is to shoot for robust economic growth. Inflation is not the concern today.

The obsession with 2% is silly, but then so is the fixation on a reported 0%.

Charles said...

Scott is absolutely right that deflation is not something to worry about. Slow, steady deflation is characteristic of a healthy economy. Productivity improvements should result in lower prices.

The concern seems to be that central banks would be unable to achieve a negative real interest rate to fix the economy. How can it be beneficial to the economy to incentivize investments with a negative return?

There is also the concern that a lower rate of inflation will lead to defaults on bonds. This is always an issue whether there is deflation or inflation. And the answer is for borrowers and lenders to be more careful. In fact what we are seeing is a very slow downward drift in the inflation rate - nothing to be concerned about.

But this whole discussion is based on the fallacy that a central bank can control the price level and interest rates, an assumption that is dubious at best.

Benjamin Cole said...


The recent history of Japan 1992-2012 and Europe (now) with deflation does not suggest a healthy economy. It suggests stagnation.

Again, we may be in deflation when the CPU-U reads 2%, and there are whole regions of the country where that is the case. Housing in the Midwest is cheap.

The biggest investment of most families is their house. Okay so the house starts depreciating for a couple decades.

And we see the stock market retreat year after year.

This is supposed to be an appealing scenario?

If you own purely government bonds, or have a sinecure as an economist at the Federal Reserve, maybe.

I don't know any business guys that want to live in deflation.

John said...

These are strange times. My measly portfolio has certainly deflated, lately, but we are busier than ever at work.

John said...

Also, what with al the QE, here we are talking about deflation. Where did all the QE money go?

Benjamin Cole said...

John - congratulations on being busy at work. The QE money was partially invested, partially consumed, and partially deposited at banks. The problem with QE was that the said was too timid in its use of that type of stimulus. In fact QE may have to become a permanent feature of a central bank's toolkit.
To those who say that QE is inert, I say, "Then fine let us pay off the entire national debt."

Joseph Constable said...

All business people with products live with deflation. It is called product life or cycle. Take flat screen TVs. Personally I waited for prices to go down as everyone knew the earlier you bought the more you would pay. The TV manufactures had a great run during declining prices. Product life is why so much effort is put into finding new products. Thank heavens for declining prices.

When I manufactured some fairly unique fuzzy socks we had a good run but had to start lowering prices as the "market matured".

Joseph Constable said...

Mr. Grannis has posted a number of compelling posts on where QE went.

I am drawn to the explanation that it filled a demand for holding money, in other words savings. If you accept that profits are savings, a whole lot of QE ultimately ended up as savings. (Now if business would just invest those profits and give money velocity a kick in the pants).

Charles said...


The real value of any fixed asset in Japan should be expected to decline because Japan is in the midst of a demographic collapse. The price of fixed assets falls because they are worth less. This is especially true of residential housing.

What makes you think deflation in Japan is a cause and not an effect?

Benjamin Cole said...

If real per capita incomes rose in Japan, then asset values could rise too.
But check out yen v dollar exchange rates 1982 to present....the Bank of Japan was tight and it suffocated their economy which actually shrank in nominal terms.
I report on Japan stock market is very sensitive to a rising yen.
What the world needs now is coordinated expansionist policies at the BoJ, Fed, ECB, BoE and PBoC....a liitle inflation is a small price to pay for robust growth...

John said...

" a whole lot of QE ultimately ended up as savings"

I think a whole lot of QE is parked offshore, out of reach of the ham-handed tax man.