Wednesday, June 18, 2014

Has U.S. inflation accelerated?

I'm posting this from Argentina, where inflation has been running in the strong double-digits for the past several years. Until recently, the government was fudging its CPI calculations, reporting inflation of only 10% per year, but public pressure and IMF threats finally forced them to 'fess up. A few months ago they scrapped the old, faked CPI, and began reporting a new CPI which so far only goes back to the end of last year. So, for the first five months of this year, the government now reports that inflation has been running at a 24% annual rate. That's a lot more realistic, given that the amount of currency in circulation in the Argentine economy has been expanding by 25-30% per year for quite a few years. It's a lot higher than the previously reported inflation rate, but lower than the 30-35% annual rate that most observers have been estimating. In any event, it's still by far the highest inflation rate of any developed country that I'm aware of.

In this context, the fact that the BLS yesterday reported that May inflation in the U.S. was higher than expected (+0.4% vs. +0.2%) is hardly something to get excited about. It is, however, significant, because as the chart above shows, "headline" inflation has accelerated in the past few months from 1.5% in February to 2.6% in May, on a six-month annualized basis, despite the fact that economic growth has been weak and the economy still has oodles of excess capacity. Core inflation has also accelerated, from 1.6% to 2.1% on a similar basis. Conventional wisdom holds that a weak economy with a lot of excess capacity should be vulnerable to deflation, not rising inflation. So conventional thinking might be wrong about how inflation works, and the Fed might be underestimating inflation.

In any event, it's too early to say that there has been a meaningful or worrisome acceleration of inflation. As the chart above suggests, inflation has been running at a 2.4% annualized rate for most of the past 10 years. It slowed down just a bit starting in 2011, so the recent acceleration might just be in the nature of "catch up."

In addition, the bond market seems inclined to believe that the inflation fundamentals haven't changed at all. As the chart above shows, the current difference between 5-yr nominal and real Treasury yields—the market's expected average inflation rate over the next 5 years—is 2.04%. That's only slightly above the 1.95% average expected inflation over the past 17 years.

I'll reserve judgment for the time being, but I remain concerned that inflation risk is something to take seriously, and I would like to see the FOMC express a similar sentiment in their release later today. It's better to be proactive about inflation risk than to wait until inflation becomes too high. We don't want the Fed to be driving by looking in the rear-view mirror.

Even though current and expected inflation is relatively benign, I note that the dollar is still quite weak historically, and gold and commodity prices are still quite elevated from an historical perspective. That's certainly not the sort of stuff of which deflation is made, and it is more symptomatic of rising inflation than low and stable inflation. Moreover, as the chart above shows, the big increase in housing prices in recent years is already driving a pickup in Owners' Equivalent Rent, which makes up about 25% of the CPI, and that component of the CPI could show a significant increase over the next year or so.

Conclusion: the Fed should err on the side of worry, rather than complacency, when it comes to the outlook for inflation.


Benjamin Cole said...

Measuring inflation is an art, including the "owners equivalent rent." What is value of Skype? Reading Grannis' excellent blog?
The PCE is restrained, would take a few years around 3 percent inflation to bring Fed back to its 2 percent average target.
I think an aggressive, growth-oriented monetary, tax and regulatory regime is needed.

McKibbinUSA said...

Assuming US inflation is real, then the best medicine would be to outlaw consumer credit for all but accredited investors (annual earnings > $300,000; net worth > $1 million) -- outlawing consumer credit would be good for US bonds, good for Federal borrowers, and good Federal beneficiaries -- I am sure Scott would agree that inflation is the number one problem in the US, and the sooner that consumer credit is outlawed for all but accredited investors, the better for bondholders and the Federal government -- let's hear it for hammering out whatever inflation remains in the US economy -- let's end inflation forever!

McKibbinUSA said...

PS: In fact, an inflation (deflation) rate of -2% annually would be really good for US bondholders -- perhaps that's the new best way forward -- we need to figure out aggressive ways to confront inflation forever -- deflation would certainly mean the end of inflation -- I am just trying to think like a bondholder...

McKibbinUSA said...

PPS: A bond-centric fiscal and monetary regime does not an economy make...

steve said...

scott, you do of realize that people have been expecting a re occurrence of inflation since the 70's only to be fooled. anyways, I suspect that measuring the difference in inflation rates between 1.6% and say 2.1% or so must be exceedingly difficult. given this and given growth that is tepid, I'm surprised
to read that you think the should err on the side of caution.

Anonymous said...

I never understood the logic for inflation as a way to stimulate economic growth.

It means Uber is bad because it reduces the amount of money that consumers spend on taxi services. It means increases in crude oil is good as it spreads increased costs throughout the economy.

Such thinkers must love the SF Bay Area rental situation where a 650 sq. ft. one bedroom apartment, mine, goes for $1,950. Ha ha. A couple from India on H1B visas are paying $2,250 for about 25 more square feet than me for an end unit. If feel like I am getting away with murder.

Encinitas Undercover said...

Very pleased to meet you. I'm an Austrian-leaning economic hobbyist just south of you in Encinitas.

I found your blog by googling "Obama Peronist" after seeing the latest news story that Obama suggested his wife would be a good president. The parallels are really striking.

Scott Grannis said...

Encintas: I've had long conversations with Argentine friends this past week about Obama. They are all amazed at how similar he is to Argentina's President Kirschner. Obama is indeed America's first Peronist president.

Hans said...

The Fed too, is under and over reporting stats as well..They are massaging numbers to please CONgress and the current despots in WDC.

So the housing percent of the CPI is only 25%! Seriously, how many households do you know, where only 25% of income is going to pay the mortgage? Zero, nada.

If this is the case, why are most banks willing and do, allow up to 35% of income to pay for a monthly mortgage payments? This is under reporting at it's best.

Watch for inflation to increase in the coming months and despite all the noise from Bank Yellen, they will continue to maintain FedZero.

The concern over deflation was a fairy tale and sold to the public along with varies "professional" economists.

As for Central America and South America, Socialism is alive and well...Gentia, is a very poignant example what the effects of a Command and Control economy will produce...

A Century in the making and millions have learned no lessons from the past, only repeat the same failures.