Sunday, February 21, 2016

Inflation is not too low, it's just right

My sense of the consensus on inflation: it's very low, threatens to go negative; central banks seem powerless to boost it, but they need to keep trying because very low inflation is a sign that monetary policy is too tight and threatens widespread corporate bond defaults. The reality, however, is quite different. As I've been pointing out for a long time, if you strip out energy prices you find that the underlying rate of consumer price inflation has been running at a 2% pace for more than a decade. Nothing has changed of late. And there's no reason to think the current rate of inflation is too low.


The chart above says it all. It's the CPI ex-energy index, plotted on a log scale. It's been following a 2% growth rate ever since 2003. Whatever the Fed has been doing or trying to do, they have delivered 2% inflation.


The chart above compares the CPI to the CPI ex-energy. I've highlighted two periods when oil prices suffered a significant decline. I think the current period is playing out almost exactly like 1986. Headline inflation collapsed, but bounced back once oil prices stopped declining.

I note that in the late 1990s inflation was about the same as it is today (about 2%) yet that was a period of very strong growth (about 4% a year for several years). Low and stable inflation is a good thing. The problem today is that oil prices have been incredibly volatile. But as I pointed out the other day, the fundamentals of the oil industry have changed dramatically thanks to new drilling technologies. Governments no longer have the monopolistic control over oil supplies that they used to have. There's a new and important source of supply, and his name is Fracking. Oil prices are not going to decline much more than they already have. Oil demand is on the rise, and new drilling has been shut down dramatically—until prices start to rise again.

Oil prices are likely to be more stable in the future than they have been in the recent past, and that will allow the underlying trend of inflation—2%—to be revealed once again.

As an aside, I should note that the "core" rate of consumer price inflation is up at a 2.3% annualized pace over the past six months. Lower oil prices may be helping other prices to rise, because consumers have more money to spend on other things.

I'm once again skiing in Park City this week, so blogging may be light.

19 comments:

William McKibbin said...
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marcusbalbus said...

give us QE

Benjamin Cole said...

The Fed says it target 2% on the PCE but uas been low for years. The market has concluded the CPI overstates inflation. Either that, or institutional investors are willing to lend their money for 10 years for no return.

The Reserve Bank of Australia targets an inflation band of 2 to 3%, and their economy has performed better than ours in recent years.

My sense is that an inflation band in the 2.5 to 3.5% range is coincident with robust economic growth.

Here is a sad observation: in 1965 the US economy real expanded by 8.5%, real terms. Easy money is a terrible thing.

Johnny Bee Dawg said...

Congress will never vote for Smoot-Hawley. All Bluster and pandering.
Trump-Rubio ticket wins the General. Trump isn't going to kill America. That's what they said about Reagan, too. Listen to the People.

Trump winning with overflow stadiums and record PUB voter turnouts. NOT a socialist.
Hillary "winning" with DEM turnout DOWN 1/3.
DEAL with it. Goldman and CFR are despondent. Can't buy or control Trump.

Trump wins Unions, blue collar working DEMS, and black males. All DEM strongholds.

Look at SC, for goodness sakes!!
Brash New York yankee ran directly against W in "Bush country" and won by double digits amongst 75% evangelical voters.
He SLAMMED W worse than ever. Every Southernor knows this was huge. Trust me on this part.

Pay attention to Electoral math....not general polling.
Assumption: Trump will carry every state that Romney carried in 2012. If he also carries Florida and either Virginia, Ohio or Michigan, he wins the election. If he manages to flip New York & Pennsylvania, he wins and would not need Florida, Virginia or Ohio. If he wins Florida (likely), Ohio (likely) and flips New York OR Pensylvania, =comfortable win. Michigan, Wisconsin, Colorado and Iowa could also go for Trump.

PUBs caused this. Trump could not exist without incompetent Obama-coddling PUB leadership. Omnibus bill in mid-December was an about-face in PUB policy. PUBs embraced and funded the Obama agenda 100% with that calculated bill. Voters are done with them. I am. This is a good thing....not a bad thing.

Johnny Bee Dawg said...

Inflation is just right, just as Scott points out. The most important market indicators held above their Jan 20 lows, and have reversed up.
We aren't out of the woods yet, and it could all change, but so far markets are still signaling the next leg is still up. The relative strength winners surged up double digit percents this past week. So far, so good!

Benjamin Cole said...

Go Johnny Bee Dawg!

I sure hope you are right, and Trump is not another GOP-socialist nationalist. I hate to tell you this, but the only GOP'er to stand down the ethanol lobby was the Canadian-Cubano, Ted Cruz. That was before Cruz got into a public argument in Espanol with Rubio.

On topic:

Another thing about this crazy central-banker fixation on microscopic inflation rates: The CPI core is 40% housing costs.

The problem is, housing is an investment, a consumption, and also is a highly regulated and artificially constrained market.

Set the builders of America free, and the also sellers of manufactured housing, and we would smash housing costs in a couple of years.

But 50-story condo towers are criminalized in Calafia Beach and most other towns, and trailers just about everywhere. The most zealous regulators and socialists are your neighbors.

We have met the (socialist) enemy and he is us.

I won't even get into what the Founding Fathers thought of standing militaries, let alone mercenaries.

Vinay Bannai said...

In a recent WSJ article, it was mentioned that Bernanke and his team were researching the strong correlation between the stock market and the oil price and came to a conclusion that 40 to 45% of the oil price is correlated to slowing demand around the world. The rest 60% is still unknown or oversupply.

It would be interesting to see the correlation of world GDP growth and oil output growth rate through the years. This should give perhaps a better answer to the question of oil price falling because of low demand or oversupply.

Francisco Javier Fernández Viana said...

Following the words of William Mc Kibbin, I just can't see your point.
I could understand that a steady rate of inflation of 2% per year is something that is not so bad for the economy, as all agents in the economy can deal with such a low rate, but much better would be if there was no inflation at all, that is 0%. That is good for savers, and makes your own currency to appreciate providing you with more consuming power of import goods
Walls and tariffs are bad for the economy, not only because Europe would create tariffs on US goods as well, but for the american consumer who will see their prices go up and their consuming power go down as less goods are able to enter the american market to free compete. On the long run, that will not create more jobs, as you say, that would create more unemployment. The free market economy needs free competition without the State and Government interfering the market. The more the State interferes, the worse for the Economy, and Walls and Tariffs are such interferences.

Scott Grannis said...

Francisco: you make good points. I probably should have said that inflation is "just right" because that is what the Fed has been targeting. I would prefer lower inflation of, say, 0-1%, but I'm not going to quibble for now.. A strong and stable currency (which implies low and stable inflation) is likely to lead to a strong economy, ad free trade is always better for the long-term growth outlook of an economy.

Benjamin Cole said...

Just remember, any measure of inflation is an artifice. Thus CPI measures a little differently from the PCE. Moreover today about 40% of non-core PCE is housing or shelter costs.

If you really wanted to fight inflation, you would decriminalize manufactured housing and criminalize property zoning all across the United States.

In that scenario, we would probably reach that Nirvana of deflation!

Matthew Grech said...

Johnny: I agree with your political observations. It feels to me that the consensus - and certainly the media - don't get the Trump phenomenon.

I always check the gambling lines to see how my feelings stack up against what monetary transactions are saying. They still have Hillary as a better-than-50% chance of being the next pres. Trump is slightly worse than 3:1 and Rubio, surprisingly to me, is also slightly worse than 3:1.

(I'd like to make clear that I don't care for Trump and will never vote for him. At a bare minimum, his views regarding torture should be seen as morally repugnant and would be seriously illegal, if enacted. But I do like the grass-roots anger that is being expressed in his political elevation.)

Johnny Bee Dawg said...

The Republican Party created Trump. Blame them 100%.

Rob said...

This Irish economist says central bankers have an "inflation bias" because they were all schooled at a time when inflation was a threat. He says deflation is the main threat these days but that central bankers are unable to see it because of their formative years. Would love to know what you make of his article, Scott: https://woodfordfunds.com/insight/fighting-the-last-war/

Scott Grannis said...

Rob: Central bankers have been worried about inflation ever since it got out of control in the late 1970s. They finally got it back under control by the late 1990s. I would agree that an anti-inflation bias persists at the world's central banks. But I think the concern about the risk of deflation is overdone. I don't know why a little deflation has to be a bad thing, while a little inflation is a good thing. In my ideal world, inflation would be close to zero and relatively stable.

In any event, I don't buy the assertion that prices are falling. As I've noted repeatedly, the core and ex-energy versions of inflation continue to rise by 1.3 to 2% per year, depending on which index you look at (e.g., GDP deflator PCE deflator, CPI).

Growth is indeed disappointing. But I think the world has put too many hopes on monetary policy to fix this. I believe that monetary policy is powerless to stimulate growth. It can facilitate growth, however, by delivering low and stable inflation. It can depress growth by being too tight. Central banks also serve an important role as lenders of last resort, which at times is necessary to keep the banking system afloat and avoid a depression. Calls for easier money (e.g., negative interest rates) in order to stimulate growth and avoid deflation are misguided and potentially threatening.

Central bankers should speak out, explain their inability to stimulate, and encourage markets to put pressure on governments for more growth-friendly fiscal policy.

Rob said...

Many thanks Scott, fascinating as always.

steve said...

JBD "The Republican Party created Trump. Blame them 100%."

Totally agree. That said, how you can support a candidate who would impose a 45% tariff on imports on the premise that it would be blocked by a GOP congress is beyond me. Honestly, that is pathetic to the extreme. If Trump gets the nod, I abstain and YES I realize that is a de facto vote for Hillary which sickens me.

Johnny Bee Dawg said...

Trump is never going to get his tariff crap enacted. But he will use it for negotiating. And he's posturing with it now. He won't get enough support for any of that.

If Trump's negatives are too great in the General, then Hillary will win. IMO, her actual policies wont be very different from those that Jeb or Rubio or Cruz would have delivered, so establishment people of both Parties won't really care one way or another. There arent really 2 Parties anymore. The current PUB Party just funded 100% of the Obama agenda instead of fighting like Gingrich did. I just want Trump to be the conduit for voter anger that busts that Party leadership right in the mouth. That's what this election is about for many Americans.

Johnny Bee Dawg said...
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Benjamin Cole said...

Go Johnny Bee Dawg!

Trump puts 'em away on Super Tuesday? Maybe.

People are saying the Fed created Trump by suffocating he US economy. Maybe so.

Welcome to Trumpland!