Tuesday, May 17, 2016

Core inflation is a solid 2%

According to the Ex-Energy version of the Consumer Price Index, inflation has been averaging about 2% per year for well over a decade. Of course, when you add back in energy prices—which have experienced gigantic swings from a low of $10/bbl in 1999 to a high of $150/bbl in 2008, to the current $50/bbl—inflation has been quite volatile. But if ever there were a time to ignore the impact of energy prices on inflation, now is the time. In real terms, oil prices today are only about 10% less than what they have averaged since 1970. So focusing on ex-energy inflation is justified and appropriate, since energy prices have increased by almost the same as all other prices, on average, for the past 45 years. Energy is not noticeably cheap nor expensive relative to other prices these days.

The chart above plots the Ex-Energy version of the CPI on a semi-log scale. It shows that inflation has had a strong tendency to average 2% per year. The only thing unusual about the behavior of inflation was in the 2006-2008 period, when core inflation reached almost 3% and ex-energy inflation slightly exceeded 3%. Since then, and despite massive increases in bank reserves, inflation has been remarkably stable and relatively low.

The chart above draws our attention to the current episode of a major decline in oil prices, and the decline of similar magnitude which occurred in 1986. Both times oil prices plunged, only to later rebound. In 1986 the headline inflation rate collapsed, then returned to the prevailing level of core and ex-energy inflation about a year after oil prices started to rebound. This time should be no different. Today we learned that the CPI increased by 0.4% in April, lifting the year over year rate to 1.1%. If the monthly increases in the CPI are only 0.2% per month for the rest of this year, inflation for 2016 would be 2.0%. That's not difficult to imagine at all.

The Fed is well aware of this dynamic, which is why they haven't panicked over the low rates of headline inflation we have seen over the past year or so. What worries them is that the economy remains sluggish and they know that the market is very nervous about the potential for higher rates to weaken the economy further. I don't think another 25 bps hike in short-term rates would do much harm to the economy, but it's hard to make a compelling argument for doing so. After all, inflation is running right around the Fed's target, and the economy is unlikely to soon defy the myriad headwinds which have been holding it back for the past seven years.

The real action these days is in the election dynamics. The future course of fiscal policy could make a world of difference to the economic outlook in coming years. But for the moment the outcome of the November elections is a jump ball. We'll just have to wait and see how things progress in the months to come. I suspect the Fed will reach the same conclusion and stand pat at the June FOMC meeting four weeks from now.


Benjamin Cole said...

Good post...but the inflation trends are down. 1.1% YoY? This is inflation or a measurement error?

Anyway, the Fed target (not ceiling) is 2% on core PCE. The Fed has missed low for years, alongside anemic growth.

Yes, the US needs lower taxes, lighter regulations, and to eliminate property zoning.

But monetary asphyxiation does not improve the regulatory and tax climate.

Lord Adair Turner says helicopter drops (money financed fiscal programs) are worth pursuing.

I wish I had a name like "Lord Adair Turner."

William McKibbin said...

Let's face it, dollars are scarce along Main Street USA -- maybe that's good -- in the mean time, I urge investors to demand higher rents and dividends regardless of the phony inflation data -- investors should be seeking value instead of growth in today's high risk markets.

Benjamin Cole said...

Query: Should the Fed raise rates and interest on excess reserves another 0.25% in June, what will happen to long-term rates? Down? I think so.

And banks get another large dollop of dough (from the Fed, at taxpayer expense) for doing nothing.

The USDA model applied to finance?

Hans said...

Second query, how will the FRS unwind excess bank
reserves, from their failed QEs?

Will they simply return all of those notes, bonds and MBS?

I can wait for any and all answers, if any.

marcusbalbus said...

i demand more qe

Matthew Grech said...

Things would have to change markedly for the better for the Fed to even contemplate unwinding its holdings. With the facts as they exist today, I expect it'll hold until maturity for roughly every piece of paper it owns. And that may not be so terrible. The unwinding question isn't even appropriate until we see the Fed stop its payments on excess reserves.

Hans said...
This comment has been removed by the author.
Hans said...

Mr Grech, are you suggesting that all of the FRS paper holdings
will mature at par?

What of the toxic MBS purchased from Fred and Fran?

And what will banks do with the excess reserves? How will the
Central Bank deal with them?

There will come a time when this issue will have to be addressed.

Scott Grannis said...

Getting rid of the Fed's MBS holdings is not too difficult: just stop rolling over interest payments and principal payments. The average mortgage is refinanced about every 7 years, so the Fed's MBS holdings could shrink dramatically in 10 years' time without having to sell anything.

Not rolling over Treasuries would work about the same way, except that the average maturity of the Fed's Treasury note and bond holdings is a bit longer than MBS.

In any event, I note that currently the Fed's holds a bit less than 20% of marketable Treasuries, which is the same as 10 years ago (before the start of QE). Of course the Fed's holdings of outstanding home mortgages have soared from pre-QE days (since the Fed never held MBS), but the Fed's share of outstanding home mortgages has been fairly steady at about 18% for the past few years.

In the meantime, raising the rate the Fed pays on reserves should, theoretically, accomplish the same result as restricting the supply of bank reserves did prior to IOER.

Hans said...

Mr Grannis, thank you for your comments.

Saxo Bank CIO & Chef economist Steen Jakobsen has penned the


"In my opinion as an economist and a market observer, people are smarter than central banks."

With such a comment and disdain for Central Crank Bankers he is not likely
to appear on or in any MSM.

"TF: Finally, you have said that continual emergency measures are unhealthy, and that’s very much where we are with central banks – negative rates, zero rates. But following the one US rate hike that happened, we saw a huge retreat from the US normalisation narrative.

If continual emergency measures are unhealthy, but the world’s arguably strongest economy has stalled on the road to normalisation, what can central bankers do?

SJ: They can do nothing. They should do nothing. They should go away.

If you look at monetary history prior to the formation of the Bank of England – the world’s first central bank – you will find that economic cycles were more stable then. Since the founding of the BoE and the Fed 102 years ago, we’ve seen an increased amount of business cycle up and downs."

If the bottom paragraph is factual indeed, then there you have the
argument and grounds to dispatch your local Central Crank Banker.
However, this would be a vast burden for the financial business media
and company, as they would have to replace this easy source for a media

"The problem is that the fractional monetary system is based on access to credit, and the only institutions that create credit in this system are the banks.

Central banks keep these institutions alive with one hand, but choke them with the other. [The result, as we see this year] is that they are underperforming relative to the broader indices, so their ability to go to the marketplace and get more money is diluted.

We have a very vicious negative cycle that is initiated by the central banks. They’re not exclusively guilty, of course, and central bankers would rebut this argument with one saying that monetary policy cannot work on its own, you also need fiscal stimulus… but that’s all nonsense."

Mish states the following:

"Bernanke, Yellen, Larry Summers, and most of mainstream media has everyone convinced that lack of inflation is a problem.

The inflationists insist prices must go up, whereas technology and free trade suggest prices should fall."

Even at a paltry 2%, there is a doubling of prices
every 36 years. Over a live span, most people cost
double not once but twice.

More insane and irrelevant monarch monetary policy from your
FRS because they know more than you.

I would suggest that neither a strong dollar and deflation are
good for the credit industry.

Whom else is sick of this inflation therapy by Dr Fed?

Hans said...


Dodd and Frankk, keeping the consumer safe by pricing them
out of the housing market!

Dodd and Frankk, great for statists whom wish for more section
8 and other governmental unit housing.

Matthew Grech said...

Hans: I never commented on, nor do I have any opinion on, the price at which the Fed's paper will mature. I assume Treasuries will mature at par, of course. MBS? Who knows? In any event, I don't think it will matter much (as you imply).

Now that you raise the issue... Whatever the discount to par (upon maturity), this will represent the transfer of wealth from the American taxpayer to the financial entities who sold the paper. This amount represents a gross injustice. And it's actually much worse than it might appear since the value of the paper today, and presumably upon maturity, is much higher than it was when it was purchased. (I.e. the Fed pissed away our money to shore up the financial entities, all in the name of rescuing the system they (and their friends) imperiled. Isn't this fun?)

Benjamin Cole said...

10 year US Treasuries at 1.84%.

Sophisticated institutional investors say inflation is dead. Or possibly the CPI overstates inflation.

Absent property zoning we might see deflation.

Hans said...

Well, Mr Grech, your paragraph nailed it, IMHO.

The taxpayers will be left holding the bank's empty bags.
We are all porters for banker's cartage.

Ben Jamin, for the record before the FRS there were only
several serious inflation periods which a Central Bank could
not have controlled.

Now, for the Central Bank consortium, inflation has become
paramount issue, requiring their overreach and interest therapy.

Again, I reiterate, the FRS is less than 100% transparent and as
Mr Grech has mentioned, not interested in serving the health and
welfare of the working public.

We can say and argue unequivocally, that the FRS is a power onto itself
with few restrictions. (banks' first responders)

Benjamin Cole said...


I certainly agree with you in one regard: In a democracy, public agencies have an obligation to be transparent, and KISS should be the rule.

For example, a tax code with 25,000 pages of impossible to decipher print is not democratic.

The Fed, with its buying and selling of bonds through 22 primary dealers, its IOER, its mysterious reverse repo buying, its closed-door FOMC meetings, its Maiden Lane entities, or the Primary Dealers Credit Facility, or any number of other arcane aspects, fails the democracy test.

Rather than the preceding claptrap, I prefer simple "money financed fiscal programs," under the discretion of the elected U.S. President. The Fed, at Presidential direction, prints money to finance fiscal deficits.

We may disagree on the level of such programs---you may say zero, and I might say $50 billion a month---but at least an intelligent layman could understand what is the policy and what we are disagreeing about. We could vote for the President who professes an inclination regarding monetary policy, one way or the other.

We have today a monetary policy even experts struggle to decipher, and disagree as to its result. No layman can understand our monetary policy. There are arcane arguments as to what really happens under QE. Is money created for not? Is QE only a "swap of reserves for bonds," or do the ultimate bond-sellers receive cash also?


Hans said...

Ben Jamin, I see you are heads up over most of us.

I just recently read about these phony "Maiden Lane" whore entities;
invoked by the FRS or as the fed calls them SPVs or Special Purpose Vehicles.
(perhaps they could get Google to have them self fund)

They clearly have worked outside of the law, by funding non-banks and foreign
entities. No one cares nor dares to say much. When it became expedient politically
to do so, they allowed Lehmans Brothers to expire.

The natural inclination of any power base, is to multiply itself with the
FRS no exception. Look for them to expand upon their past record.

This link is an excellent read - for those whom care.


William McKibbin said...

Here's the problem with the economy that must be fixed before we do anything else...


Benjamin Cole said...


The US Constitutional authority for much of what the modern-day Fed does is lacking. But then our Founding Fathers loathed, detested and reviled a standing military as well, and preferred citizen-soldier militias to be the backbone of our war-making ability.

We lived with citizen-soldiers through WWII and the Korean War. Now we have a professional, federalized and permanently mobilized military, exactly of the type feared by the Founding Fathers. As taxpayers, we pay the price every year, btw, as these federal employees are entitled to lifetime medical care in federal facilities staffed by federal employees, and get full pensions after 20 years of employment. The right-wing embraces communist health care programs, when it comes to GOP-affiliated groups. Is that Constitutional? What would a "strict constructionist" say?

Not a polite question.

In 1926, the U.S. Supreme Court ruled that local and state governments could zone property. So property rights mean nothing in the USA. Your land can be downzoned right under your nose. Or, as you are connected, you can buy land and then get it up-zoned. I guess that is constitutional too.


The U.S. Constitution is a extraordinarily maleable document.

I think "strict constructionists" mean they strictly construct the meaning of the Constitution to their ends!

Hans said...

Ben Jamin, I would suggest that the rightwingers would do away
with the incompetent VA system, however, too many Repubcos
are either RINOcans or moderates.

Regarding the previous citizen-soldiers defensive, will be returning
in due time as the cost of operating the ALL volunteer military is not
cost effective. Around 2035, wages and benefits will account for the
entire war department budget.

Maybe we can outsource of security to Old Mexico?

This from Cafe Hayek . com..

I have always contented that this is how GU spending should
be examined and not as a percent of GNP.

" The situation was even worse than Mencken reports here, for he forgot a digit: federal spending in 1935 was $14.8 billion.

Here’s a quick back-of-the-e-envelope calculation:

Adjusted for inflation (using the CPI), $14.8 billion 1935 dollars is the equivalent of about $258.47 billion in 2016 dollars. Because the U.S. population in 1935 was about 127.3 million, that means that Uncle Sam that year spent about $2,030 (in 2016 dollars) for every man, woman, and child in America. Today Uncle Sam spends annually a hair under $4 trillion – let’s call it, conservatively, $3.9 trillion. Therefore, today Uncle Sam spends annually – for every man, woman, and child in America’s current population of about 322 million – approximately $12,110. That’s annual per-capita spending approximately 6 times greater than what Uncle Sam spent in the year when Mencken penned the above quotation."

Benjamin Cole said...


I'll say it again-- Federal agency spending should be cut in half, civilian and military.

There should be no pension programs for any public employee, state, local, federal civilian or military. Such programs are inevitably time bombs.

At this juncture, I do not see how we can replace Social Security and Medicare. We can only hope to cut spending.

Hans said...

Ben Jamin, anything is possible if there is a will!

One could return to the old system, wherein "public" semi-workers could
receive lower pay in return for an excellent pension.

Anything is doable, including SS and M & M (elimination) but I am afraid there is no
"public" will for it.

Economics, will have to do the dirty work for the complacent citizenry .

If I were the Triumphant President Trump, I would instruct CONgress three
chores; first, past an annual budget; second, eliminate a federal department;
third, a complete new tax code with no corp tax and a simply 5% flat tax
on all, with no deductions.

If this is not done, escort each and every CONgress member home.