Watch Out For Hawks
Todays’ release of the March inflation figures is sure to get the hawks out in force. So duck for cover. What one media outlet refers to as ‘red hot’ inflation is rising up to the top of the hawk list of reasons to hammer at the average family. After all we have to protect, at all costs, those dear creditors who might at some point get upset with us, and raise interest rates on the money they lend us.
That we could do without them is never mentioned. That the folks who wring their hands about the need to protect the creditors are, well, our creditors, is usually not noticed. That they are the self same bankers who marched us recklessly over the cliff in 2008 is also never mentioned. Why would it? It’s the bankers doing the talking, and we all know how incredibly savvy and smart and so very attuned with risk all bankers are. They never make mistakes with credit risk. So what they say about the money markets should guide us as we ponder what to do about inflation.
Nothing.
That’s what we should do.
Nothing.
First: March’s CPI rate was 0.5%, which means that inflation has shot up over the past twelve months by all of 2.7%. You’re kidding right? 2.7% is just fine thank you. Go home and do something else. But do not worry about inflation.
People do though. I hear it all the time: people don’t believe the official numbers because they face what they feel is a different situation. That 2.7% rise masks a set of very divergent figures. Fuel and food, in particular, have risen much more sharply than that. Since most people buy food and fuel very frequently they face that more rapid price movement and then extrapolate to everything else. However, most people do not spend all their money on food and fuel. In fact those items are not even half an average budget – the poorer you are the more important as a percentage they become. Other stuff fills the rest of the average budget, and the price of that other stuff has fallen, or not risen much at all, for a while now. That’s why we look at ‘core’ inflation and strip out the volatile items like food and fuel which have a history of gyration. Only two years ago their prices were dropping rapidly, while core prices meandered along sideways. Now they’re rising just as rapidly, but core prices are still meandering along sideways.
In short, we have no inflation problem. Certainly not one that requires a policy response.
Second: but what if we did?
If core prices were rising abnormally, let’s say wages were getting higher rapidly – hard to imagine right? – what should we do?
Nothing.
A dose of inflation, say in the 3% to 4% range would be very healthy. It would allow us to reduce debt burdens, and so free up cash flow for consumption. It would help push the economy forward. One of the most salient features of the Japanese disease we appear to have caught is persistent low inflation. Indeed deflation was more the concern than inflation. A great benefit of higher inflation would be that it would produce higher negative interest rates. In other words, as long as the Fed keeps rates near zero, one way they can create lower interest rates and thus boost demand, is to allow inflation to creep up. This has the effect of lowering inflation adjusted rates. It’s a sneaky way of achieving the goal, but it would work.
Third: if we react to recent inflation pressure by raising rates we risk giving up GDP growth right as we are about to reduce it anyway through ill advised government budget cuts. We would be tightening monetary and fiscal policy simultaneously. The result would be a dramatic slowdown in the economy, and, potentially, a rise in unemployment. So we need to keep our foot on the monetary policy gas despite the string of higher inflation figures we’ve seen since late last year.
Fourth: the most important single contributor to long term inflation is wage costs, and wages are stagnant. Adjusted for inflation wages fell 0.6% in March. That implies a pre-adjusted figure showing a decline of 0.1%. There is no wage pressure at all. So producer costs, while they are rising due to raw material cost increases, are under no urgent overall inflationary pressure. Wages are the thing to watch if we are monitoring the likely path of future core inflation. Since they are dormant. So is long term inflation.
Not that you could tell from the reporting of this morning’s announcement. The hawks are out and are clutching at anything they can to get policy to tighten. Ignore them.
Or at least watch out for them. Then ignore them.
Addendum:
For the way in which the media botches inflation consider this headline: “Rising gasoline, grocery costs eat up worker wage increases”.
Not true.
For the simple reason there were no worker wage increases to be eaten up. What happened is that rising prices compounded the decline in wages.
Workers were slammed twice, not once. With wages falling and prices rising a real squeeze is on demand. So reacting to inflation as if it were a long term problem – which it is not – would add insult to injury. It would add another cause for concern to workers already weighed down by our economic policy failure to pump up aggregate demand.
By focusing only on price increases the media is allowing the much more important story to go untold. Our biggest issue is inequality and especially the stagnation of wages even while productivity rises nicely.
Profits have boomed. Wages are flat. I have said it repeatedly. I will say it again. Most our economic ills are rooted in that one very simple relationship.
