by Fabius Maximus, FabiusMaximus.com
Summary: Today we look at inflation, past and present. It tells much about who to trust for economic analysis, the current state of the US economy, and what we can expect in the future.
- The inflation picture
- Why has inflation fallen since 2011?
- Others see the rise in real rates
- For More Information
During 2010 and 2011 the media overflowed with confident and dire warnings from conservatives of inflation — or even hyperinflation — coming quite soon. They were totally wrong, as economists such as Paul Krugman said at the time. Instead inflation has slowed, by some measures hitting record low rates. As the posts at the end show, readers of the FM website saw the correct side of this debate (this has been added as a win on the Past Predictions page).
Today we look at what actually happened, and what this might mean for our future.
(2) The Inflation Picture
The public looks at the CPI to measure inflation. Many economists (e.g., Alan Greenspan) prefer the Personal Consumption Expenditures (PCE) price index. The April numbers (annualized):
- overall PCE: -3.0%
- core PCE (excludes food & energy): +0.1% (the YoY change of 1.05% is the lowest on record, back to 1960)
- trimmed mean PCE (another measure of the core rate): -0.1% (lowest since record begins in 1977)
Three of the most important economic factors appear on this graph:
- Treasury interest rates (blue, here that of the 10 year bond),
- inflation (green, here using the CPI), and
- real interest rates (red, here measured by the difference between the two).
Click to enlarge
We see the effects of the Fed’s increasingly aggressive monetary policies, intended to boost CPI inflation and lower real interest rates. They have not done these because the recovery is wonderful, but because it is too slow. Note that one of these is unlike the other two.
- QE1 from November 2008 to June 2010 — it broke deflation, boosting the CPI and forcing down real rates.
- QE2 from November 2010 – June 2011 — another boost to CPI, further depressed real rates.
- QE3 from October 2012 — still running, but with inflation falling and real rates rising.
Houston, we might have a problem.
A strong recovery pushes up nominal rates, as demand for funds increases and the Fed pulls back monetary stimulus. Eventually capacity utilization increases (including for labor), and inflation pops up. That’s not the US today. Nominal rates were flat until recently; real rates rose only due to falling inflation. Recently nominal rates have risen on excitement over forecasts of GDP growth accelerating through 2016 (doubling to 4.5%, a rate not seen since 2000).
It’s not what we have today. Falling inflation has become a problem.
The Fed has set a “floor” for inflation at 2%. Deflation is horrific for a high-debt economy like ours, and the floor allows the Fed time to take preventive action — as Bernanke described in his famous “we have a printing press” speech in 2002, and has he did after the crash in 2008.
Rising real interest rates act to slow the economy, not what we need now as GDP growth has limped along since 2009 at the 2% “stall speed rate”. The government has applied fiscal and monetary stimulus when it slows much below that (where recession risks increase).
Slow growth, inflation falling towards zero, and rising real interest rates — an ugly combination for the Fed to deal with, especially with the monetary throttle already pushed beyond the gates into “unconventional-seldom-successfully-tried zone (see this article to put current policy in a larger context). Until this picture changes, I doubt the Fed will pull back (“taper”) its monetary stimulus.
Let’s hope that one (or better yet, two) of these factors improves. Rapid growth would do the trick.
(4) Why Has Inflation Been Slowing Since Fall 2011?
Lots of theories. I have seen no good explanations. Falling commodity prices. Slower growth in health care prices. Stagnant wages in real terms. Slow growth creating excess capacity utilization. Slowing global growth creating more price competition. Strong US dollar vs Japan and Europe.
We should wait for research before guessing about the answer. But I’ll guess anyway.
The 19th century long peace of 1815-1914 was a deflationary era (tendency to deflation, with frequent depressions). The next era, after a long painful transition, was the inflationary post-WW2 era. Now we have entered a new transitional period, perhaps with social and technological factors again creating a structural deflationary tendency.
(5) Others See The Rise in Real Rates
(a) “CHART OF THE DAY: There’s One Chart Responsible For The Tectonic Shift In Global Markets“, Matthew Boesler (journalist), Business Insider, 12 June 2013 — Excerpt:
And while the rise in real rates is likely a sign of good things to come, right now, it’s causing jitters over the prospect of the removal of monetary stimulus from the market by the Federal Reserve. In the past few weeks, those jitters have caused a bout of weakness in stock markets from the U.S. to Europe, from Japan to emerging markets, and almost everywhere in between.
All of this begs the question: are central bankers finally losing control of long-term interest rates, which for years following the global financial crisis of 2008 have been their most powerful policy instruments?
(b) “Too tight or back to normal? “, The Economist, 11 June 2013 — It’s happening in other developed nations. Excerpt:
AN INEVITABLE consequence of the falling inflation and rising bond yields referred to in a recent post is that real yields have risen, as the chart (from Patrick Legland at Société Générale) shows. Real yields in the euro area are now on a par with those in Japan.
In this respect, financial repression is disappearing; the US and euro area are no longer inflating away their debt. One aim of Abenomics is surely to drive down real yields by allowing inflation to rise to 2% without a concomitant rise in nominal bond yields, which would make the financing of government debt look perilous.
(6) For More Information
Posts about inflation:
- Is the US Government deliberately underestimating inflation?, 8 November 2007 — No.
- Can Obama turn America into something like Zimbabwe?, 22 February 2010
- The Fed is not wildly printing money, as yet no hyperinflation, we’re not becoming Zimbabwe, 2 March 2010
- Why the U.S. cannot inflate its way out of debt, 15 March 2010
- We can try to inflate away the government’s debt, but we’ll go broke before succeeding, 16 April 2010
- More invisible signs of looming US inflation!, 22 February 2011
- Inflation is coming! Inflation is coming!, 7 February 2011
- Inciting fear of inflation in our minds for political gain (we are easily led), 28 February 2011
- Update on the inflation hysteria, the invisible monster about to devour us!, 15 April 2011