Inflation Eases; Wages Fall

There is no real sign of a burst of inflation. This must upset those who long for an uptick so they can support their argument that we need to raise interest rates to stem such an uptick. Hitherto the inflation hawks have had to look to ghosts and made up stuff to help their cause. The imaginary inflation they saw as an “inevitable” result of the Fed’s QE2 has just not been realized. As we all knew it wouldn’t with the economy stuck firmly – too firmly – in the mire of a liquidity trap.

The numbers released today have overall inflation of -0.2% in June; and core inflation at +0.3%.

Obviously the big story is that the overall figure was distorted downwards by the rapid cooling off of energy prices, which dropped in the index by 4.4%. This was the unwinding of the spike in prices earlier this year, and was entirely expected by those of us with a calmer head and not inclined to look for those inflationary demons. Having said that we must all watch the core figure: it has edged above the Fed’s uppermost limit for the last couple of months. What seems to be causing this is an inertia in prices. The spike in energy costs during the spring is now baked into the prices of goods that are included in the core product list that are now finding their way out to consumers. This has the effect of creating an ripple or wave of higher prices well after the spike has subsided in the overall basket of products that include pure energy products as well as the core products. An example might help: an automobile is a product included in the core product mix. When the cost of energy rose that higher cost added to the cost of the car. Subsequently, as manufacturers sought to recapture that higher cost they raised the price of cars. So as the new car rolls off the production line its price is shown as rising even though the cost of energy by that time may be falling. If this is true, and I think it is an entirely plausible explanation for what we are seeing, the full impact of the spike’s disappearance will be delayed until the new, lower cost, shows up in the end products that comprise the core basket.

All that is by way of saying that I don’t see inflation as an issue. Especially in view of the flat to down trend in wages. Remember: it is wages that are the major driver of inflation over the longer haul, and we are seeing no evidence at all of wage pressures mounting. As a point of reference, core inflation rose 1.9% over the twelve months ending in June. That’s within the Fed’s target.

This morning’s report on earnings shows wages, adjusted for inflation, rising in June by 0.2%. But as we can tell from the inflation figure, that entire increase is attributable to the drop in prices. Actual wages were flat. Worse, for those of concerned about the impact weak wage growth is having on the economy, hourly wages fell by 1.5% over the year ended in June. The situation is better than it was when the inflation was rising so quickly during the energy price spike, but unadjusted wages are stuck in the doldrums – as we would expect during a period of high unemployment – are are thus not a factor to instill fear into the tremulous hearts of the inflation hawks.

Not they have show a terrific willingness to bolster their argument with facts.

But that’s another story.

Oh. One last thing. I have said before, and I should repeat it now: given that we are in an economy constrained by the debt burden on households, and given that we will not accelerate much until that debt burden is significantly reduced, a bout of moderate inflation – which has the effect of reducing debt burdens – would be a mighty useful thing. Conversely, any action to restrain inflation or to raise interest rates would, obviously, have the opposite effect. It will prolong the stagnation. Bear that in mind as you listen to pundits discuss what to do about our non-existent inflation problem.