Developments in Inflation

November 18, 2009

The United States and Canada reported new consumer price statistics today, and Euroland and British data were released within the past week.  The comments of central bankers would have us think that if low and stable inflation can be secured, all other economic problems will be manageable.  The latest 12-month inflation rates are minus 0.2% in the U.S., minus 0.1% in Euroland, minus 2.2% in Japan, minus 0.8% in Switzerland, minus 0.5% in China, plus 0.1% in Canada, plus 1.3% in Australia and plus 1.5% in Great Britain.  Although a recovery in emerging markets is now spreading to advanced economies, global economic prospects still look fragile and overly reliant on unsustainable macroeconomic stimulus.  Price stability helps but is only one of many conditions for economic well-being.

U.S. inflation has bottomed.  The all-items CPI rose 3.5% at a seasonally adjusted and annualized pace during the six months to October, a huge swing from a 3.9% pace of decline in the prior six months to April 2009 and even higher than the 2.7% annualized climb in the six months to October 2008.  Core inflation of 1.7% in the latest 12 months is up from a trough of 1.4% last August.  A previous cyclical upswing crested in July 2008 at 5.6% for all items and 2.5% on the core CPI index.  To get a better sense of the state of U.S. inflation, I like to compare decades. U.S. CPI inflation in the current nearly-completed decade has averaged 2.6%, practically the same as the 2.5% per annum pace of the 1960s.  In between, U.S. inflation heated up to 7.4% on average in the 1970s, then cooled to 5.1% in the 1980s and 2.9% in the 1990s.  The CPI rose 2.2% in the 1950s.  Core inflation has slowed to 2.2% per annum this decade, from 3.1% in the 1990s, 5.7% in the 1980s, and 6.7% in the 1970s, and it’s been lower in the present decade than the 2.6% pace in the 1960s.  Had Fed officials been watching equity prices instead of limiting their gaze to the prices of goods and services, they would have observed a 1.0% per annum decline this decade in the Dow Jones Industrial Average, a dramatic reversal from positive growth of 15.4% per annum in the 1990s and 12.6% per annum in the 1980s.

The Canadian CPI rose 0.1% in the year to October, well below the target of 2.0%.  Inflation averaged 2.1% this decade and 2.2% per annum in the 1990s.  Core inflation of 1.8% in the year to October was near to its 1.9% pace this decade.  As in the United States, Canadian inflation appears to have passed an inflection point, rising at a 3.2% annualized pace between August and October.  Previously, inflation peaked in 2008 at 3.5% on all items and 2.4% in the  core measure.

Central bank priorities are shaped by historical traumas, resulting in important differences despite the cross-fertilization of economic theory.  Germany’s hyper-inflations in the early twentieth century remain the defining impressionable moments for ECB policymakers, whereas the Fed’s most enduring lessons emerged from the Great Depression.  Euroland’s on-year CPI inflation of minus 0.1% in October was similar to America’s, but such had a lower average pace of 2.2% this decade than the U.S. rate of 2.6%.  Even more telling, core inflation in the euro area is still subsiding.  Such was 1.0% in October compared to a decade pace of 1.8% and a high-point of 2.7% last year.

Britain, where the Bank of England took sole responsibility over interest rate policy only 12-1/2 years ago, has a legacy of run-away inflation, which spiked above 25% in 1975 and returned to double-digits later that decade and again in 1990.  The CPI, which the Bank of England targets at 2.0%, climbed 1.5% in the year to October.  That’s down from 5.2% in the year to September 2008.  Core CPI stands now at 1.8%.  The older retail price index, which recorded identical 2.6% average rises in the 1990s and this decade fell 0.8% in the latest reported twelve months.

Then there is deflation-struck Japan, where after increasing just 0.4% per annum in the 1990s, the CPI eased 0.2% per annum in the present decade and 2.2% in the latest 12-month period.  Japan’s price deflator for domestic demand, part of the recently released third-quarter national income accounts, fell a record 2.7% from 3Q08.  According to that measure, Japanese deflation has deepened from 1.6% per annum in the 1980’s to 0.4% in the 1990s, minus 0.9% per annum in the current decade and minus 2.7% between 3Q08 and 3Q09.

As a personal note, my career in economy watching began in the mid-1970s, a period of upwardly spiking inflation just about everywhere, not merely the United States.  When my experience in the field was still comparatively limited, I came to see future inflation lurking behind every higher-than-forecast price, wage, and growth observation.  Economists at the time viewed inflation as the normal outcome, and price stability as an elusive goal attainable only if central bankers in particular but also politicians and bureaucrats worked awfully hard at containing it and in addition had a bit luck.  That widely shared view was in fact mistaken.  My revised opinion is that inertia is a central property of inflation.  Yes, it is very hard to wring inflation out of an economy once it is in place.  But by the same token, it is very difficult to create an inflationary process from a base where no such pre-condition exists.  Experts, who study plane crashes, say that there causes seldom stem from a single misstep but rather from a cascade of catastrophic mistakes.  So it is with inflation.

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


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