Larry White is an outstanding free market monetary theorist at the University of Missouri in St. Louis. At the Division of Labor blog he notes that although the nominal price of gold is back to the level of 1987 it remains much lower in real terms, after adjusting for the 75 percent rise in prices since then. But the real price of gold has nearly doubled over the past four years, which he interprets as hedging against inflation:
“The upsurge in gold over the last four years suggests that that investor confidence may be slipping again – and not without good reason. As Bloomberg reports: So far this year, consumer prices are rising at a 4.9 percent annual rate compared with a 3.7 percent increase at the same time last year.”
Yes, but . . .
So far this year, consumer prices less energy are rising at only a 2.0 percent rate -- down from 2.2 percent at the same time last year. Energy prices in the CPI rose 12 percent in September alone, but fell slightly in October.
If we look at the superior chain-weighted CPI, prices were up only 1.7 percent over the past twelve months for all items less food and energy. Food is rarely a significant factor (I'd prefer to drop the "core" measure), and food prices were up only 2.1 percent over the year while energy prices soared by 26.3 percent. Leaving out energy alone, the chained CPI would be close to 1.8 percent over twelve months. Since even chained price indexes exaggerate inflation, because of quality improvements and hidden discounts, an inflation rate of 1.8 percent for everything except energy is really quite low.
The main reason this distinction matters is not that rising energy prices don't hurt, or even that global oil demand is only indirectly related to Fed policy. The key reason we absolutely must look at inflation without energy prices is that energy prices cannot and will not keep rising forever. When they stop rising, we'll see how the underlying rate of inflation really is.
If the chained CPI less energy remains around 1.8 percent, then total inflation will likewise drop to about 1.8 percent if energy prices merely stabilize, and to a rate below 1.8 percent if energy prices keep falling.
It is theoretically possible that non-energy prices might accelerate if energy prices fall, because cheaper energy frees-up cash to spend on other things. In the past, however, spikes in energy prices in 1974-75, 1979-81 and 2000 were always followed by slower inflation in non-energy prices for at least a year or two. The Fed’s notion that energy inflation spreads like a virus from energy to everything else is factually false.
Non-energy inflation is now lower than it was during in any year from 1967 to 2001, and also lower than last year. So relax and enjoy a happy new year. But maybe it's time to trim those hedges.
Alan, I appreciate your offering some insight on this issue. I've always held the view you ascribe to the Fed because it seems so common-sensical. After all, you need energy to get all the other goods to market, thus if that price is up, all the others must follow. Thanks for the further analysis on the point.
ReplyDeleteI'm trying to hash this out ... please bear with me.
ReplyDeleteLets say that you have a fixed amount of money to purchase goods and energy. If the energy prices go up (and are inelastic) that will reduce the money supply for non-energy goods, right?
This implies a reduced level of inflation for non-energy goods at times when energy prices have spiked (this seems to be contrary to what Hunter stated).
Now, when the energy prices come back down, the money available to purchace non-energy goods will go up, resulting in inflation (of non-energy goods).
Question to you economic experts: is my analysis too simplistic, and if so, where (why) does it fail?
Thanks...
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ReplyDeleteA couple of comments to add to Alan's observations:
ReplyDelete1. That the publicized "inflation" data are biased upward is suggested by longer-term interest rates, which appear low in nominal terms (the real rate plus an adjustment for expected inflation.
2. The recessionary ("deflationary") effect of rising energy prices has not been discussed very well in the mainstream press, perhaps because most of the journalists are morons.
3. At the same time, I think that Alan may be understating the overall spending effect of falling energy prices. Unless the energy spending reductions get stuffed into mattresses, the dollars will be spent somewhere. Will prices in those sectors rise? That depends on supply conditions, etc. Who knows?
4. But Alan's larger point is correct: Energy price increases cannot be "inflationary" in the classic sense, because an increase in one set of prices yielding reduced spending and thus prices in other sectors is not "inflation." It is a change in relative prices; our snapshots at various intervals of the "price level" indicates changes in the level of prices, but not a quais-permanent change in the rate at whcih prices change.
5. And that is why the Fed's (Ben Bernanke's) price rule is potentially mischievous: The Fed will be led to interpret a change in relative prices as "inflation."
I'd like to see a post by either Alan or Ben on the new chairman of the Fed. Like him? Don't like him? Would have preferred somebody else? Hate the fed?
ReplyDelete