Tuesday, November 15, 2011

Producer Price inflation moderates

Producer Price Inflation has been elevated for the past year or so, but inflation pressures have moderated in recent months, thanks largely to a decline in energy prices: on an annualized basis, the headline PPI is up only 1.9% in the past three months, while the core PPI is up only 1.1%. This is likely only a temporary respite, but it is nevertheless welcome, since we have enough to worry about these days with all the concerns emanating from the Eurozone.

Once again I'll highlight the fact that for the past several years the core PPI (ex-food and energy) has been rising more or less steadily, despite the huge decline in economic output in 2008 and the presence of an extraordinary amount of economic slack that has been characteristic of the recovery ever since. I believe this is a testament to the power of accommodative monetary policy, and it goes a long way to disproving the Phillips Curve theory of inflation, which has been predicting very low inflation or even deflation due to the large output gap that has persisted since 2008. Both the core and headline levels of the Producer Price Index are substantially higher today than they were in mid-2008 (4.0% and 4.6%, respectively). With monetary policy still very accommodative, it only makes sense to expect that inflation is more likely to rise than fall as time passes.

As this chart of crude oil futures prices shows, the respite from lower energy prices is already a thing of the past. Crude has surged by 30% since its early-October low.

This chart compares crude prices and wholesale gasoline prices (orange line). I think it shows that the decline in crude was probably exaggerated by speculative forces (short covering?) during the summer; crude prices fell much more than gasoline prices, and thus the rebound in crude should probably be discounted to a great extent. Regardless, these two prices will inevitably track each other as time passes, and right now crude seems to be leading the way higher.

We can also thank the ongoing and significant decline in natural gas prices in recent years for helping to keep energy prices relatively subdued. Natural gas is down fully 75% from its 2008 high, while crude oil is down by only 33%. As the second chart above shows, natural gas hasn't been this cheap relative to crude for decades, thanks to significant new drilling techniques which have resulted in a natural gas production bonanza in the U.S. It is hard to underestimate the degree to which cheap and abundant natural gas is going to transform U.S. manufacturing and energy generation in the years to come.

1 comment:

Benjamin Cole said...

Lots of good news out there--unit labor costs are declining and PPI is going down. Inflation is not a worry at all. Deflation still a threat.

I think there is now a disconnect between US macro-policies and commodities prices. There are larger consumers of commodities than the USA, such as China. Oil is a fishy market anyway, with OPEC and Russia and speculation running rife.

Sometimes, partisan groups fall into shibboleths, and then fail to change when times change. We have food programs and a nation of fat people. We have ag subsidies and nation of very smart and wealthy farmers. We have an oversized military complex and we have out-of-date affirmative action and poverty programs.

"Fighting inflation" is one of the battle cries of the past. As we see in Japan, the threat is more often today from deflation, and an abundance of capital.

I hope a new right-wing can emerge, dedicated to reduced agency spending and vigorous economic growth and an monetary policy that target nominal GDP.

More defense spending and tight money is the road to ruin.