Monday, March 29, 2010

Measured inflation is still benign

I've been worrying about rising inflation for most of the past year, mainly because of the Fed's extremely accommodative monetary policy (e.g., zero interest rates, plus the injection of over $1 trillion of reserves to the banking system in exchange for mortgage-backed securities). My concerns have not been unfounded. When I look at sensitive indicators of the net effect of monetary policy, I see abundant evidence that there is an excess supply of dollars in the world: the dollar is within 5% or so of its all-time lows against other currencies; gold prices have risen from $260 to $1100/oz.; TIPS 5-yr forward breakeven spreads have risen from almost zero to 2.7%; the Treasury yield curve is as steep as it's ever been; credit spreads have narrowed significantly across the board; and commodity prices are up steeply across the board.

Yet as the chart above shows, measured inflation is within the Fed's target zone of 1-2%, as measured by the Personal Consumption deflator (February figures, included in the chart, were just released today). Am I wrong to worry about rising inflation?

I must admit that I thought inflation would be higher by now, but then I've never called for anything more than a "gradual rise in inflation," so I'm not off by too much. As Milton Friedman counseled, the lags between monetary policy and inflation are long and variable, so I take some comfort from that and am content to wait longer before throwing in the towel.

UPDATE: I would dearly love to be wrong on my rising inflation call. I really hope the Fed will not again make the mistake of keeping interest rates too low for too long, as they did from 2003-2005. Inflation is very unkind to the poor, the innocent, the trusting, and the naive, and it has wreaked havoc in most of the world's economies from time to time. Given the beating the economy is taking from Obama's wanton spending proclivities (which unfortunately greatly overshadow the Bush administration's excesses), higher inflation is the last thing we need right now.


septizoniom said...

asset price inflation is aleady rapidly on the rise.

Benjamin Cole said...

sept- What assets? Where? The DJI below 1999 levels and real estate roughly the same.

Gannis: Scott Sumner of Cato says the problem is tight money--he says tight money caused the recession, and that the Fed should shoot for 5 percent growth in nominal GDP.

Scott Grannis said...

I love Cato, but I don't agree with everything they say. It is arguable whether tight money caused the last recession, but I believe that tight money has caused every post-war recession. What certainly contributed to the recession was the Fed's too-tight policy in the late 1990s, followed by too-easy policy from 2003-2006, followed by a tightening of policy in 2007-2008. Erratic monetary policy has been a huge problem for a long time.

I don't think the Fed can target nominal growth. They should just stick to targeting low and stable inflation, and stabilizing the dollar against a basket of commodities and perhaps other currencies would go a long way to achieving that.

Charles said...

Owner equivalent rent is dragging down the CPI. Most people don't feel this and so inflation seems higher.

This won't last forever.

Scott Grannis said...

Note that OER is not really a factor for the Personal Consumption Deflator, as it is for the CPI.

Benjamin Cole said...

The monetarists have interesting arguments, and there is no disputing Hume's insights on MV+PT.

But there is a lot of unadmitted murk in the monetarist perception--what is the money supply, M1 or M2 or M3 or some other combo?

And match that question for other nations..what are their money supplies?

Then what are the effects of the global money supply on the US? And on commodiities prices?

If we have a globalized economy, it seems to me then we need a globalized money supply and concordant control (which leads to scary One World Order sorts of specters). We need a World Bank that controls the global money supply. Boy, that will go over well with America's right wing.

Sheesh, speaking of paper money supply (currency), there are hundreds upon hundreds of billions of dollars of cash in circulation, thought to be outside US borders.

And even if w know M, can we know or influence V?
Or T?

In the end, monetarism requires faith. People say "if such and such prices rise, that means the money supply rose." Although I suppose it could also mean V rose.

It is telling that you have monetarists such as Cato's Scott Sumners and other monetarists reaching diametrically opposed views.

Monetarism is a branch of economic groping in the dark for lack of good data.

Scott Grannis said...

I have tried, obviously in vain, to explain that money supply is a nebulous concept, and that the so-called measures of money supply that we have (M1, M2) are probably better measures of money demand than money supply.

But the central observation of supply-siders is that you don't need to know what money supply or money demand are. They can each be represented by a curve, and it is their intersection that tells the tale. If the value of the dollar is declining, then that must, must mean that the supply of dollars exceeds the demand for dollars. Similarly, if prices of sensitive assets are rising strongly, it most likely means that money supply exceeds money demand. And the source of inflation, as Milton Friedman always said, was an excess of money supply relative to money demand.