U.S., Canadian and Euro Area CPI Inflation and Some Thoughts on Deficit Reduction

December 20, 2011

Whereas on-year total U.S. consumer price inflation in November of 3.4% was a half percentage point above the Canadian pace of 2.9%, those neighboring North American economies had similar underlying or “core” inflation rates of 2.2% and 2.1%, respectively.  Total inflation over the past five years averaged 2.3% per annum in the United States, 0.2 percentage points (ppts) above the annualized Canadian pace.  Likewise the ten-year consumer price inflation rates of 2.5% in the United States and 2.3% in Canada also favored the northern neighbor by 0.2 ppts.  U.S. core inflation was considerably lower over the past five years at 1.5% per annum than the prior five years (2.1% per year). 

CPI inflation in Euroland has been lower than in North America.  Total consumer prices went up 3.0% over the last twelve reported months but climbed 2.1% over the last five years and during the five years before that period.  Core inflation stands at 1.6% currently, the same pace as sustained over the last five years and down from 1.8% per annum in the five years to November 2006.  This pattern of slightly less inflation is consistent with respective central bank goals.  The European Central Bank targets total, rather than core, inflation and responds to deviations in that measure, which tends to run higher than inflation that excludes commodities like energy and food.  The ECB’s target is below, but close to, 2.0%, similar to the implicit Fed preference but lower than the Bank of Canada’s objective pace of 2.0%.

Fiscal hawks in the United States worry that excessive deficit spending that is accommodated by loose monetary policy and a rapid build-up of the the central bank balance sheet is a recipe for considerably higher inflation with insufficient warning to adjust macro-economic policy in a timely manner.  The fear is that all the hard-work of erasing inflationary psychology over the past generation could be undone very fast.  In fact, however, the inflation problem of the 1970s did not erupt suddenly, and it did not develop without the aid of strong economic growth. CPI inflation rose 1.2% per annum in the five years to end-1964, 3.9% per annum in the next five years to end-1969, 6.6% per annum in the first half of the 1970s, 8.1% per annum in the second half, 6.5% per annum in the first half of the 1980s as corrective measures began to be taken, and 3.7% in the second half of that decade.  Core inflation, which advanced only 1.3% per annum in the five years to end-1964, slightly lagged the acceleration of total inflation and also lagged total inflation in subsiding after cresting.  In the second half of the 1980s, core was still above 4% at 4.3% per annum.  There was plenty of time as inflation took deeper root to reverse the problem, but it was politically more difficult then than now to risk recession in exchange for lower inflation.

In the early stage of America’s inflationary buildup, real GDP expanded 4.3% per annum in the first half of the 1960s and at a 4.4% pace in the second half.  As late as the second half of the 1970s when inflation containment fell apart during the Carter presidency, real GDP still advanced at a heady 3.9% per annum, and the pace of growth throttled back only to 2.5% per annum in the first half of the 1980s and 3.5% per annum in the second part of the decade.  In order for a combination of loose monetary policy and high deficit spending to transform into excessive inflation, it is necessary for the potential spending power that the Fed’s rising balance sheet represents to be actually used.  That isn’t happening.  On the contrary, real GDP grew just 0.6% per annum in the five years to 3Q11, down from 2.7% per annum in the five years to 3Q06 and 3.6% per annum in the five years to 3Q01. 

The fiscal deficits that exist now are not the product of discretionary fiscal decisions.  They result instead from weak economic growth sapping tax revenues.  To tighten fiscal policy in response is transform the framework of that macroeconomic tool from being counter-cyclical as intended to being pro-cyclical.  In this new orientation, it would be government’s role to make recessions deeper and expansions more frothy.  The United States has a serious fiscal deficit problem, but such is the long-term deficits ten, twenty or fifty years down the road if corrective actions are not taken well in advance.  It is regrettable that the inability of the nation’s two political parties to compromise on this issue is causing Washington to shrink America’s near-term deficits rather than the ones many years away.  Worse still, it’s not possible in the current weak global environment to cut one’s fiscal deficit when every nation is trying to do the same thing.

Copyright 2011, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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