Friday, July 17, 2015

Inflation alive and well at 2%

As I've been reporting for the past few months, inflation according to the CPI is running a solid 2%. June figures released today in fact suggest it might be picking up a bit.

Huge swings in energy prices have made headline inflation statistics quite volatile in recent years. Taking out energy prices, however, reveals that inflation has been pretty steady at 2% per year for the past 15 ½ years, as the chart above shows.

Over the past six months, the core (ex food and energy) rate of CPI inflation has actually risen at a 2.3% annualized pace. The headline rate has risen at a 1.3% annualized rate in the past six months and at a 3.5% annualized rate over the past three months. Absolutely no signs of deflation here—the real issue is whether we're in the early stages of an acceleration in inflation or not. Still too early to tell, but this bears watching.

The chart above attempts to show that changes in housing prices can be an important driver of inflation with an 18-month lag. The blue line shows the year over year change in housing prices according to Case Shiller, while the red line shows the year over year change in the Owner's Equivalent Rent subcomponent of the CPI (which makes up about 25% of the total CPI). Rents by this measure are up almost 3% in the past year, reflecting the acceleration in housing prices in the past several years.

Speaking of the housing market, today's June data for housing starts were much stronger than expected, and now show that the housing market has been quite strong this year.

Building permits have been on fire of late, rising 30% over the past year! This, combined with the recent rise in homebuilder sentiment (see the preceding chart above), strongly suggests that housing starts will continue to rise in coming months.

Inflation is alive and well, and so is the housing market. And, most likely, so is the U.S. economy. The Fed is absolutely justified in beginning to raise short-term interest rates, and the sooner the better, in my estimation.


Unknown said...

Thank you for "housing prices feed into inflation" chart.

Unknown said...
This comment has been removed by the author. said...

1.5 or 2 percent is still thievery. I object to the idea of a two percent inflation 'target', meaning it is a goal, to have 2 percent inflation. It should be a 'redline', that when it hits that level, action should be taken to get it to zero.

Benjamin Cole said...

The Fed targets 2% average on the PCE...and has been below target for six years---while the economy grew ever so slowly.

The current fixation on inflation is a very poor monetary policy. People forget the boom-boom Reagan days when inflation ranged from 4 to 6 percent, or the 1990s when we also had moderate inflation.

I like prosperity. Prosperity should be the object of monetary policy. In a perfect world, utopia, maybe there is no inflation. Here on earth inflation goes hand in hand with real growth.

Speaking of housing inflation, what are the prospects of the City of San Clemente will decriminalize 60-story condo towers, thus boosting supply, fighting inflation and the local economy?

Scott Grannis said...

To my knowledge there exists no theory that would explain why 1.5% annual inflation on the PCE deflator instead of 2% would result in slow economic growth. Monetary policy should focus on keeping inflation low and stable. Fiscal policy should be the tool that is used to manage growth, not monetary policy. Inflation is caused by too much money, not by a shortage of housing.

Benjamin Cole said...

Egads I disagree with part of your last response Scott.
You are a supply-sider. Obviously boosting the supply of housing will fight inflation.
Presently, any place it's pleasant to live in the United States has criminalized robust new housing construction. Sidewalk or pushcart vending is also generally illegal in the US.
I believe the supply side is important---we can and should boost demand through a growth oriented monetary and fiscal policy, but free up the supply side too.
I don't know how to end NIMBYism in the USA however.

Unknown said...

Scott, what is your forecast for residential real estate over the next 2 years? In particular, do you see the issues in China affecting RE in SoCal directly. I fear a redo of the Japanese in Hawaii a few years back when their stock market froze.

Scott Grannis said...

Re: residential real estate. Everything I see points to continued growth in residential construction and home prices. As for Japan/Hawaii, Hawaii is a pretty small market compared to California, and its proximity to Japan has traditionally meant that when Japan sneezes, Hawaii catches a cold. The relationship between China and SoCal real estate is not likely to be as significant as Japan/Hawaii.

In any event, the big thing going on in Japan is that capital flows have reversed in the past year or so: money is leaving China. Undoubtedly some of that money is finding its way to SoCal real estate markets, and the local buzz supports that: Chinese buyers have been active and they more often than not pay in cash. But I don't think they dominate the market, and I don't think they will disappear just because China is growing at a slower rate. Chinese stocks are still up 33% from year-ago levels, in any event, so the parallels to Japan a few years ago are not very tight.

Scott Grannis said...

I should add that in my experience driving around SoCal, there is plenty of evidence just about everywhere of a pickup in construction activity, both residential and non-residential. Much more activity today than a few years ago.