Inflation and Foreign Exchange Movements

October 15, 2009

The effects of the weaker dollar were apparent in yesterday’s release of U.S. import prices, showing the core non-fuel component jumping 0.6% in September — the most since July 2008 — on top of a 0.3% increase in August.  Today’s CPI data produced marginally higher monthly increases than forecast for total consumer prices and the core index.  However, evidence that exchange rate movements affect inflation can be better seen in comparisons of U.S. inflation at a seasonally adjusted annualized rate last quarter, which was 2.5%, compared to inflation elsewhere.  Inflation in the euro area ran at minus 1.2%, including negative 1.1% in Germany and Italy, minus 0.7% in France, minus 2.3% in Spain, minus 3.4% in The Netherlands, minus 4.0% in Ireland and +0.1% in Belgium.  In Japan, consumer prices fell 1.6% at an annualized rate between May and August, and such dropped 2.0% annualized in Tokyo during the third quarter.  But in Great Britain where sterling had also been depreciating, consumer prices climbed 1.8% annualized last quarter.

Is higher inflation associated with a softening currency a bad thing to experience?  Not at all in current deflationary global circumstances.  In fact, this development should be openly embraced.  The big move in inflation since last year is sharply downward even for economies like the United States and Britain because of the emergence of enormous unused labor and capital resources.  U.S. consumer prices fell 1.3% in the year to September, whereas Britain’s CPI firmed 1.1%, down from a climb of 5.2% in the prior statement year to September 2008.  That 4.1 percentage point (ppt) drop was less than declines of 6.2 ppts each in Ireland and the United States, 6.5 ppts in Belgium, 5.6 ppts in Spain or 4.3 ppts in Japan, but such exceeded the decreases of 3.8 ppts in France, 3.6 ppts in Finland, 3.5 ppts in Germany and Italy, 2.8% in Holland, or even 3.9 ppts in the euro area as a whole.  On-year core inflation is now at 1.5% in the United States, down from 2.5% in September 2008.  Euroland and Britain have core inflation rates that also now lie between 1.0% and 2.0%, specifically 1.1% and 1.7%, while a drop of 2.4% in Japan’s core CPI in the year to August was the greatest 12-month decline since at least 1971.

From a central banking standpoint, price stability is the most important economic goal because it is the economic variable over which monetary policy has the most direct long-term influence.  However, having low inflation from a society’s overall sense of economic well-being ranks below the goals of brisk economic growth and fully employed labor, plant and equipment.  Low and stable inflation are a means to this ultimate prize most of the time, but conditions have not been normal for quite some time.  In spite of a chronically suspect dollar, the U.S. experienced a milder recession than Europe or Japan and is expected to expand faster in 2010 than those economies.  The October Economist Poll of forecasters produced projected GDP increases next year of 2.5% in the United States but 1.4% in Japan and 1.2% in Euroland.

Copyright Larry Greenberg 2009.  All rights reserved.  No secondary distribution without express permission.


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