"There is always a philosophy for lack of courage."—Albert Camus

Thursday, April 28, 2005

Inflation Illusion Update

My next column “Illusory Inflation” is already up at townhall.com. It’s full of boring numbers showing that if you pull energy out of the most accurate inflation statistics, there has been no acceleration of inflation since the recession of 2001. None, zip, zero. If the Fed thinks otherwise and acts on that misconception, I argue, they could aggravate the global economic squeeze caused by steep energy costs.

Since my deadline is Wednesday, I did not have the GDP figures released on Thursday. That includes the Fed’s favorite inflation index, the one for personal consumption expenditures (PCE). The “core” version of that PCE deflator, which excludes both food and energy, is up only 1.6 percent from a year ago. Looking at the first quarter alone, it was up at a 2.2 percent annual rate. But those quarterly figures bounce around too much to show a trend -- up at a 2.6 percent rate in the fourth quarter of 2001, for example, 2 percent in the second and third quarter of 2001, and 2.1 percent in the first quarter of 2004.

You won’t read any of this in the business press. They’ll report that "core" inflation was up 3.2 percent in the first quarter, not 1.6 percent. But that 3.2 percent "annualized" figure is for just three months -- that is, it's a 0.8 percent increase multiplied by 4 to show what it would look like if it continued for a whole year. And that GDP price index is for the whole economy -- including business expenses -- which is not how most people (including the Fed) define inflation. "Cost of living" does not mean the cost of doing business.

Besides, business costs for materials and such in the GDP price index are relatively unimportant in comparison to unit labor costs, which are barely rising at all. And rising costs don’t easily translate into rising prices anyway, because of intense competition from imports. The PPI does not predict the CPI, for reasons explained in my column. The apparent quarterly uptick in nonlabor business costs might squeeze profit margins a bit, but it's not inflation.

Aside from energy, the year-to-year trend in consumer prices is no quicker than it was three or four years ago – just 2 percent or less. So, unless you think the Fed should raise interest rates when oil prices go up and lower interest rates when oil prices go down, it is hard to justify a Fed "policy" of just raising interest rates again and again until something bad happens.

1 comment:

Anonymous said...

Alan -- Your polyannaish view on inflation is really quite mystifying. As someone who recalls your use of the gold price signal from your days at Polyconomics, it seems remarkable that you would focus on the relatively modest year-over-year change (which at the time your column was published was actually 12% not, as you suggested, unchanged), ignoring that over the past two years gold is up about 30%, which is also the degree to which it is now trading above its 10 year moving average. The history of the relationship between gold and broader price pressures clearly indicates that the price level will move to equilibrate with this decline in real dollar purchasing power, meaning that a period of rising inflation is inevitable.

You also seem to take perhaps undue comfort from the still-subdued current readings from the official price indexes. To be sure, the year-over-year changes at this point are nothing to be alarmed about in an absolute sense, but a trend shift has become pretty apparent in all of these measures. Yes, core PCE is up just 1.7% year over year, but it was up by less than 1% in late 2003. It's also seems puzzling that you would put so much store in year-to-year changes, suggesting that shorter-term rates of change are somehow spurious. Don’t you think shorter-term change rates provide useful information during potential turning points, when year-over-year change will necessarily be a lagging indicator? It seems that for whatever reason, you'd just prefer not to acknowledge the signals being sent from a shorter-term perspective. Over the past three months, for example, core PCE is up at a nearly 3% annual rate. It also seems clear that the dollar's weakness against foreign currencies the last few years is definitely beginning to show through in import prices. Year-over-year non-petroleum import prices have risen 2.9%, versus just 1% a year ago.