Wednesday, June 16, 2010

Producer price inflation update

Here's the latest update on inflation at the producer level. The core PPI is only up 1.3% in the past year, but it is up at a 2% annualized pace over the past six months. Total inflation is up 5.1% over the past year, and 3.6% annualized over the past six months. Draw a line down the middle at you might conclude that the underlying rate of producer price inflation is somewhere in the range of 2-4%.

I like this next chart, which plots the level of the producer price index on a semi-log scale. The chart divides inflation history into "regimes" that are in turn based on the stance of Fed policy.

The Fed was effectively a passive entity in the early 1960s, because we were on a strict gold standard. Not surprisingly, inflation was effectively zero back then. Beginning in 1966 the Fed began to stray from the gold standard, keeping interest rates low in spite of a gradual outflow of gold, and inflation became significantly positive. Inflation took off beginning in 1974, in the wake of the devaluation of the dollar, and the Fed was ineffectual at trying to stop it all through the 1970s. The Volcker Fed then brought it back into control in the early 1980s. But for the past six years inflation has been more volatile and generally higher than at any time since the early 1980s. Since 2004 the underlying rate of inflation has been about 3.5%. 2004, not coincidentally, was when the Fed switched to an overtly accommodative policy stance after having been generally restrictive since the early 1980s.

Inflation is not dead, it is alive and well. Deflation is not a risk.


Benjamin Cole said...

On a long flight to the Far East, I recently read "Against The Gods," a book by Peter L. Bernstein about managing risk.

The book reminds readers the sea changes in investment returns are possible. Stock yields (dividends) exceeded bond yields forever, then that pattern reversed in the 1970s, and has stayed reversed.

Inflation and interest rates were low forever (barring a post-war spike), then ballooned in the 1970s, and have been subsiding ever since.

If we have core PPI at one percent or so, I guess I cannot say "inflation is deader than Jimmy Hoffa" but certainly inflation is under control.

Who knows? Maybe Jimmy Hoffa will come out of the woodwork someday. and maybe inflation will be a threat again.

But there is a lot working against inflation now. The nation's workforce in increasingly nonunionized, and markets are global. There is too much retail space on the market, nationally.

Output per hour has been rising nicely, and unit labor costs have been going down, not up.

All manufactured goods and commodities generally get cheaper over time, not more expensive (with the exception of militay hardware).

I have not heard of anyone lately who thinks they can make a price rise stick.

Monetarism? You can't push on a string. And the figures show we are not even pushing on the string.

Inflation is no Jack Armstrong.

Charles said...

3.5% seems to be about right for overall inflation. I think, given the fragility of the financial sector and the euro difficulties, it is prudent for the fed to maintain its present course for another 3 to 6 months.

While real interest rates are negative, the monetary aggregates do not suggest that a serious acceleration of prices is inevitable.

The demand for cash and cash equivalents is high which is why investors are willing to pay to hold cash.

When, as I expect, the fear of a double dip subsides and it becomes clear that a very slow but real recovery is underway, investors will start to move out of cash and the price of deflated assets will start to recover a bit. Eventually, this will spill over into the price of goods and services and unemployment will fall to perhaps 8% and inflation will become a serious issue. Given the policies of the Obama Administration, 8% is probably now full employment.