Friday, June 26, 2009

Core inflation update

This chart shows the core rate of inflation (ex-food & energy) according to the Personal Consumption Deflator, on a year-over-year basis, as well as the annualized rate over rolling two-year periods. Once again, it's a "dog that didn't bark" story, since core inflation has not fallen this year as conventional wisdom would have predicted. In fact, the core deflator is up at a 2.4% annual rate for the first five months of this year, despite a significant slump in demand which has left consumer spending today about 5% below where it would have been if the trend of the past few years had not been interrupted. So much for the theory that economic "slack" should result in falling prices, or at the very least a slower rate of price inflation.

The import of this is that the Fed continues to believe in a theory of inflation that isn't very good at predicting inflation. The Fed's theory is telling them that inflation risk is extremely low because the economy is so weak. Thus, they are likely to remain very easy, or too easy, until it becomes obvious that the economy has picked up. That strategy is likely to result in higher-than-expected inflation over time, especially in the current environment: key inflation indicators such as 1) the value of the dollar (weak), 2) gold prices (nearing $1000/oz.), 3) commodity prices (up strongly across the board), and 4) a very steep yield curve are all signaling that measured inflation is likely to be rising in the coming months and years.


alstry said...

So much for the theory that economic "slack" should result in falling prices...

Unless of course you are in the market for buying a house or yacht or plane or exotic car or commercial building or beachront property...;)

Marinas can be had for a song as well if you want more than just the boat. You won't believe some of the deals crossing my desk....but few are able to predict and/or factor the impact of the carbon tax on returns down the road.

Crazy times indeed.....

狂猪 said...

Hi Scott,

I have been following your blog for some time. I've learn a lot and really enjoyed your analysis.

On the issue of inflation, I am really not sure. Krugman had a lecture at London School of Economics on this crisis. I was wondering if you can share your thoughts on the points Krugman made. I think he made substantial arguments that inflation is not a concern and definitely not in terms of priority.

Please see the "The Return of Depression Economics" lectures.

Also, what do think of Brad Setser's analysis that there is a net reduction on total US borrowing (public and private) with regards to inflation?

By the way, here is my current take. I think what the Fed is doing right now is good for the economy and is necessary. However, I do have a lot of doubts on rather the Fed can unwind in a timely fashion in a year or so for two reason.

1. politically unwinding is difficult.
2. the worry of repeating Japan by unwinding too early and therefore undermining the recovery

As such I think the Fed will likely err on the inflation side. I think pickup of inflation will be faster than Fed can unwind.

However, I think the key question is how much faster? I don't mind if the Fed is a little behind but a lot behind is a problem. I am really unclear on this.

What do you think will cause the Fed to be a lot behind?

Scott Grannis said...


As for Krugman, he is so politically biased that he has lost most of his credibility as a professional economist. His arguments against inflation are very much in line with what the Fed is saying: the economy is so weak and unemployment so high that prices can't possibly go up. Some prices are falling, of course, but the official numbers, and the leading indicators I mention in my post, say that overall prices are still rising.

The reason he is wrong is that inflation is a monetary phenomenon, not a by-product of growth. I have lived in a country with hyperinflation and depression. Inflation and a weak economy have no trouble co-existing in my experience.

As for borrowing, it has nothing to do with inflation. Yes, government borrowing is way up and private borrowing is way down, but that has no impact on inflation in any event.

We both agree the Fed is unlikely to reverse its liquidity injections in a timely fashion. I think the only debate at this point is how high inflation will be. I think it depends on a lot of things, but I am not ready to say we are headed for a huge increase in inflation. An investor doesn't really need to know how high, though, all he or she needs to do is decide whether it will be higher than the 2% the market is expecting. I think that is an easy decision--it will be higher.

alstry said...


I need your say:

"As for borrowing, it has nothing to do with inflation."


So for the sake of a hypothetical, if I could borrow... let's say $10 Trillion dollars at low interest rates and start buying millions of houses and renovating simultaneously, I wouldn't cause inflation by injecting huge quantities of money into the economy affecting millions of jobs???

What the heck just happened over the last eight years???

I think I need to go back to school.

Scott Grannis said...

alstry: you need to get a grip on your logic. If I borrow money from one person and spend it, he will have to spend that much less. Borrowing doesn't create money (unless the Fed monetizes it, but then we're talking monetary inflation), and spending borrowed money doesn't inject any money into the economy.

alstry said...


I am not borrowing for one person....I am borrowing from a bank that is levering up its capital base as permitted under fractional reserve banking.

The money that I borrowed NEVER existed until I borrowed it under our current banking system....there is case law to support this assertion.

Scott Grannis said...

As I said, if the borrowed money comes from the Fed, that is indeed inflation. But if you borrow money from someone else, it's not.

Borrowing per se is NOT inflationary. Excessive monetary expansion is. Let's be clear about our terms.

Scott Grannis said...

Consider this: the federal government will be borrowing well over a trillion dollars this year, but only a small portion of that will come from the Fed's purchases of T-bonds.

alstry said...

Sorry Scott,

I should have made it clear that the only place to borrow $10 Trillion was the Fed without draining the entire world of its liquidity.

Now this accumulated debt is the toxic assets the Fed is trying to clean up.

The Therapist Is In said...

Why is Krugman so politically biased? Meaning NY Times or other entities?

dave said...

You are confusing money and credit, they are two different things.
Only the Fed can create money, not banks.If the Fed creates too much money then inflation is the result. Too little money and the stronger dollar produces deflation.

What banks and citizens do with that money can not cause deflation or inflation.

Scott Grannis said...

Therapist: I can't explain why he is so politically biased, but it's become ridiculous. Maybe it's the culture of the NY Times.