Consumer Price Index

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Inflation and von Mises

Yesterday I speculated that the decline in the cost of basic goods like gasoline was a contributory cause of the uptick in retail sales in October. Today’s consumer price report supports that notion.

The headline rate of inflation, the consumer price index, declined 0.1% last month bringing the rate for the last twelve months down to 3.5%. That’s a large decline in the annual rate – in September it had been 3.9%. In contrast, the more important “core” rate, which strips out volatile items such as gasoline and food, rose 0.1% and has risen 2.1% over the last year. The biggest factor behind the decline in the headline rate was a 2.0% drop in energy prices, while food prices rose, but only a slim 0.1%.

The decline in the CPI, coupled with a very slight increase in hourly wages, meant that inflation adjusted earnings rose 0.3% for the month. This modest improvement in incomes appears to be the basic reason retail sales were slightly stronger than expected.

The importance of this report is simply that it debunks, or helps to at any rate, the notion that expansionary monetary policy deployed to get the economy going will inevitably feed into inflation. This is a view held by many right wing analysts, and has no substance or foundation, but exerts a tenacious hold on their thinking. It has it modern roots in the writings of von Mises, and still occupies a leading role in right wing economic policy thinking even though such right leaning luminaries as Milton Friedman considered the idea daft. If you recall we were treated to an outburst of terrifying warnings of imminent hyperinflation this summer when commodity prices drove the CPI up temporarily. The cause of those warnings was the right winger’s view that recent Fed actions such as QE1 and QE2 could only create inflation and not help the economy. In von Mises words:

“Attempts to carry out economic reforms from the monetary side can never amount to anything but an artificial stimulation of economic activity by an expansion of the circulation, and this, as must constantly be emphasized, must necessarily lead to crisis and depression”

There’s not much wiggle room in those words. The analysis is definitive: tinkering with the money supply necessarily leads to crisis and depression.

That it hasn’t, ought, in a scientific world, permanently disprove von Mises’ view. It won’t. It will linger on because of its ideological purity. But it isn’t science.

But we could say that about a lot of economics.

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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.

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Mixed Up Numbers

We have had a number of economic statistics this week all of which seem to be muddied by the weather or unusual trends that make it difficult to tell what’s going on.

For the last few Thursdays I have been warning you not to take the weekly new claims for unemployment assistance data too seriously. Unfortunately last week I allowed myself to slip a bit and make the nutty suggestion that the drop to 383,000 was unlikely to be reversed. It was. Oh well such is life in the fast lane. This week’s 410,000 demonstrates the bumpiness of the claims data and sent everyone scurrying for explanations. The best most folks could come up with was to resort, once again, to the bad weather and slow reporting from outlying parts of the country. That may well have something to do with it. Looking at the data over the last two months, it has ranged all over the lot, and while a downward trend seems to be there, it has ben swamped regularly.

So I have decided to adopt a simpler approach.

The jobs market continues to suck.

This view is supported by the almost total absence of new job generation. New job addition to payrolls has averaged 83,000 in recent months which, while better than nothing, is derisory. At that rate our unemployment problem will persist for a decade. That is intolerable and unbelievably damaging to the nation’s long term health. The longer we fail to come to grips with unemployment the more our national skills inventory erodes, the greater the social costs we suffer, and the spill over effects into things like consumption, real estate sales, savings and so on pile up.

Not that you could tell we have an unemployment problem by listening to the debates in Washington. There debt hysteria has taken such hold we no longer have serious economic policy, we have something more akin to a teenage mania. Policy makers have taken leave of their senses and are now somewhere disconnected from the rest of us talking amongst themselves about a problem they created a long time ago as if it were brand new.

Accountability, honesty, and responsibility are not in abundant evidence in Congress at the best of times. Now they are on the endangered species list. A list, by the way, that will no longer be kept once the Republicans cut the budget for it. The idea seems to be that when everyone is stupid no one stands out as being so.

Meanwhile back in the real world: last month’s inflation figures have also been released and provide ammunition for everyone. The inflation panic crowd will look at the headline 0.4% as being quite a jump and probably a portent of things to come. They will, no doubt, bang the austerity and higher interest rate drum even more stridently. The rest of us, being the cool calm folks we are, will look past the headline figure and focus on the fact that food and fuel prices drove a good part of the increase. We will look at the “core” number, which was a more benign 0.2%, and argue that inflation is not an imminent threat. Looking at the last year inflation is not a problem by either measure. While the core rate rose at e very low 1.0%, the more volatile total rate only rose 1.6% despite the energy component rising by 7.3%. Since the Fed has a target of around 2.0% that last twelve months suggests we have ample room to maintain an eased approach. Of course that’s not very easy since we have been bumping along the bottom for a while now with no latitude except for the much maligned quantitative easing that the hawks, in their frenzy, want to reverse.

One last comment on inflation: in a separate report the government announced that average hourly wages fell at a 0.1% rate in January. This means that for the past twelve months wages have risen a paltry 0.2%. For comparison – not that I am trying to make a point – corporate profits rose by over 26% during the twelve months ended last September. Hmmm.

One last muddled view: manufacturing.

The much touted Philadelphia Fed index of activity in its district hit a seven year high in recent weeks. that’s the good news. On the down side is the national report on manufacturing output that slid 0.1% in January. This latter figure was something of a shock since the consensus view was that manufacturing is in rude health and was expected to register a 0.4% gain. The surprise sent the analysts resorting to the bad weather explanation. This time they may have a better case. For instance utility output has swung about wildly lately as bad weather ramped up demand, December’s usage was very high, so when January settled back a bit towards normal levels it dragged output down. Looking inside the numbers tells me that manufacturing is still growing and that the January data was distorted a little. As one example: output of business equipment grew 0.9% in January, not very different from the 1.0% in December. And surveys of factory managers tell the same story: higher demand and growing activity.

So what do we make of all this confusion?

Basically that the economy is growing, but that it isn’t generating jobs. Of course we knew that already.

Oh, and Congress doesn’t care. It has gone off chasing ghosts.

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What Inflation?

If there is one economic factor that the experts on Wall Street have consistently been wrong about, it is inflation. Ever since the great intervention in the economy after the Lehman implosion these analysts have been explaining that the consequent huge increase in the money supply would inevitable – inevitably – produce a sharp increase in inflation. This line of reasoning has been taken up by the right wing echo chamber and is now approaching full blown cacophony.

For two straight years we have been lectured by these orthodox economists and their various political hanger-on that the policies of the Fed and our neo-socialist government will do nothing but untold harm to our economy. Those policies will, they say, lead not to economic health, but to economic ruin brought on by the debasement of the dollar and an associated, uncontrolled, burst of inflation. It is this prospect, so they say, that is preventing businesses from investing, and is undermining consumer confidence.

Government is the problem.

Where have we heard that before?

Those of us who argue differently are dismissed as crazy interventionists who don’t realize the consequences of this supposedly reckless monetary regime.

Well.

Let’s look at the facts.

Inflation, when we take away the volatile stuff like food and fuel, has steadily chugged down a disinflationary path. The experts have been wrong in their forecasts for twenty-four months and counting. It is this adjusted, or core, measure of inflation that we look at to understand the trend of prices within the economy. Food and fuel prices jump about all over the place and tend to mask the underlying trend. This is not to say that those jumps are not real, but that they do not signify anything of deeper meaning within the overall price structure of the economy.

And what is today’s news about consumer prices?

The unadjusted Consumer Price Index rose just 0.2% in October. Core inflation was flat for the third month in a row, and has risen only 0.6% over the last year. This is the lowest level of core inflation ever reported. The trend line is still downward. We are perilously close to deflation and getting closer each passing month.

In other words the facts completely refute the imminent inflation disaster argument. Utterly and totally refute it.

Not that I expect it to go away. Those who fan fears of inflation do so on the basis of two things:

  1. An ideological dilike of government intervention in the economy
  2. A misreading of the economic situation

The ideology is well known and often drives otherwise sensible people to hold odd and anti-socail policy positions. The second is less well known, but is more pernicious since is based upon wrong headed economic theory.

So, to make my case once again: We are stuck in an odd economic situation. The normal outcomes from an expansionary monetary policy, assuming strong employment and demand, could be upward pressure on prices. That assumes the economy fails to expand in real terms in response to the change in money supply. But. These are not normal times. In fact we are so far from normal that we may not return there for a decade or more. We have an economy with a very large gap between its capacity or potential and its actual level of activity. We are going through a steady reduction in debt, and that implies a loss of cash for spending. We have very weak employment to go with this weak demand. Flooding money into this kind of economy may reduce interest rates enough to stimulate activity, but it will not shift prices.

Think about this from a practical business point of view. In the face of weak demand for your products, it makes no sense to raise prices. It makes sense to cut them.

If enough businesses cut enough prices we enter deflation.

If demand for the stuff needed to make consumer goods is sufficiently weak, those prices will drop too. And that includes wages.

The only reason that commodity prices are jumping about at the moment is that many emerging economies are growing well. It is not a reflection of overly strong demand in the developed economies.

So the experts are absolutely wrong. Inflation is nowhere in sight. Those folks who signed the letter published in the Wall Street Journal two days ago were urging the Fed to back away from its “inflation inducing” policies. Their point of view is thoroughly debunked by today’s news.

Will we see them change their mind in view of the new facts?

Of course not. Why let facts get in the way?

Fact based policy making is so yesterday.

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Inflation … What Inflation?

Just a brief note on today’s inflation report: those of you expecting more action from the Fed to stimulate the economy will have that expectation reinforced. Inflation in September, as measured by the Consumer Price Index, was a meager 0.1%. Over the past twelve months it has been 1.1%. And that’s including a 5.1% increase in gasoline prices. If we take out the volatile food and energy component of the index we see that “core” inflation was just 0.8%, the lowest annual rate since 1961. That’s way below the bottom of the Fed range and perilously close to deflation. There’s not much more to say other than numbers stuck in this range are likely to provoke the Fed into action sooner of later. I have argued many times that we could do with a healthy bout of inflation to ease our debt burdens. In an economy bent on ridding itself of debt inflation is a boon. So those who fear the inflationary consequences of more monetary easing in the form of QE2, are likely to get those fears confirmed. Oddly that will be a good thing. As long as we rein it in later on.

But that’s a long way off. Right now inflation is not our problem, potential deflation is.

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