Is a Change in the Trend of Consumer Price Inflation Looming?

Readers may recall our recent article “Inflation in the Nation”, where we commented on the recent jump in CPI to 2% annualized. As we noted, it is interesting that the economy's production structure has once again been markedly distorted by the Fed's inflationary policies, in particular, while capital goods production has revived strongly, consumer goods production has stagnated (see this chart for details). This would, ceteris paribus, favor an increase in consumer prices, or at least a shift in relative prices to the detriment of capital goods prices.

We also added a chart to a recent article by Bill Bonner, in which he discussed the growing gap between the MIT's 'Billion Prices Index' and CPI. Here is the most recent chart (unfortunately it only shows the situation up to the end of April, but the trend is clear even so):

 

Billion prices-index

The 'Billion Prices Index' (BPI) vs. CPI. There is now a growing gap between the two.

 

If we look at the history of the year-on-year change rates of the BPI vs. CPI, we can see that the former appears to lead the latter when divergences emerge (unfortunately the sample size is very small, so we have to take this information with a grain of salt).

 

Billion prices-index-change rate

The y/y change rates of BPI and CPI – last time a divergence was in evidence, BPI turned out to be the leading indicator.

 

The reason why we are discussing all this, is that Marty Feldstein recently uttered a warning in a WSJ editorial about growing 'price inflation' pressures, noting that the Federal Reserve appears to be 'behind the curve' (this is of course only natural – it always is, as it drives with its eyes firmly fixed on the rear-view mirror).

 

A Good Laugh at Feldstein's Expense?

A report published at Marketwatch, discusses Feldstein's warning. We certainly don't always agree with Mr. Feldstein's economic views, and we cannot say whether his prediction will turn out to be correct this time. However, something quite interesting happened after he issued his warning:

 

“Inflation is already rising faster than the Federal Reserve’s 2% target and presents a near-term challenge to the central bank, said legendary economist Martin Feldstein on Tuesday. Feldstein, now an economics professor at Harvard University, was in the running to replace Alan Greenspan for the top Fed spot in 2006.

In an op-ed in the Wall Street Journal, Feldstein said “the key to the future” is how the Fed will respond if prices continue above 2% annual target.

“A misinterpretation of labor-market slack, and a failure to create a positive real federal-funds rate, could put the economy on a path of rapidly rising inflation,” Feldstein wrote. Feldstein said the Fed’s rhetoric on inflation makes him worry that the central bank “may not react quickly and aggressively enough if inflation continues to rise above 2%.”

His views were greeted with some derision, like this tweet from Mark Thoma, a professor of economics at the University of Oregon.

(Surprise!!!) Warning: Inflation Is Running Above 2% – Martin Feldstein http://t.co/40ZQDkrOnc

 

We don't know anything about Mark Thoma, but it seems to us that his derisive tweet is symptomatic for the currently quite widespread consensus that 'inflation is not a problem'. In fact, if anything, most economists are worried about 'inflation being too low', or are even fretting over the alleged 'threat' of deflation.

As Janet Yellen's reply to a question by Marty Feldstein on occasion of a recent appearance of hers reveals, this is also the consensus view at the Fed:

 

“Feldstein pressed Federal Reserve Chairwoman Janet Yellen on how the central bank would respond to higher inflation during her appearance before the New York Economic Club in April.

The Fed chairwoman replied “the risk is greater that we should be worrying about inflation undershooting our goal and getting inflation up to 2%.”

She added that the Fed “absolutely will be committed to protecting inflation if it threatens to rise persistently above 2%.”

 

(emphasis added)

As our readers know, our thinking about inflation is quite different from the mainstream's. To us, the term inflation is the designation for an increase in the money supply. Rising consumer prices are just one of many possible effects of money supply inflation, and the question of if and when money supply inflation will lead to rising consumer prices mainly depends on contingent circumstances. The only thing that is absolutely certain is that money supply inflation leads to a 'price revolution' across the entire economic system, as it leads to massive distortions of relative prices (which is incidentally the main reason why capital goods production has boomed while consumer goods production has stagnated).

So, is there an 'inflation problem'? Indeed, there is.

 

TMS-2-LT-ann

The 'inflation problem' illustrated – click to enlarge.

 

However, central banks only react to inflation if and when it begins to impact CPI. Should Mr. Feldstein's forecast turn out to be correct, it will certainly surprise the socks off a great many people. It would also be anathema to the current bubble in financial assets, as this bubble is predicated on the idea of administered interest rates remaining at zero for as far as the eye can see.

 

Conclusion:

When warnings about inflation meet with ridicule, it may actually be a good time to take them seriously.

 

charts by MIT, St. Louis Fed

 

 

 

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4 Responses to “Inflation Warnings Ridiculed”

  • Kreditanstalt:

    woodsbp: yes, PRICE inflation is an outcome of MONETARY inflation. I think we all agree on that. There has been for some time now a cascade of talking heads here in North America saying “there’s no (price) inflation”. Maybe these people don’t shop for necessities, or more likely are so wealthy that necessities are a vanishingly small portion of their shopping.

    Food is an interesting measure. Package sizes are shrinking. Weights of cereal packages are now as low as 250g a box but prices are not coming down commensurately with weight. Quality of ingredients seems to me to be deteriorating; a quantity of the fruit and nuts in cereals is being replaced with more flakes. We’ve seen meat prices up a good 10% this year alone. Coffee is also up similarly and they’re playing with weights in each can there too. 960g is now 920g, and so on. Sales are less frequent. Discounts for larger quantities gradually disappearing. Discounted nearing-sell-by-date items are snapped up more quickly than a couple of years ago, and more people shop at the discount warehouse type supermarket instead of the (expensive) chains like Safeway…

    Aren’t these examples of inflation (price inflation) too? I mean, come on, guys…! Prices are rising – in food alone – at something like 10%p.a…. They seriously need a better measuring stick.

  • Kreditanstalt:

    Someone should devise a workable measure of price inflation in NECESSITIES only. Stuff you HAVE TO buy: basic foods, energy, gas, taxes, utilities, &c., and nothing else.

    I’d guess nearly all of us could agree that price inflation in those items is far above either CPI or BPI…

    • zerobs:

      I am ecstatic that you put taxes in your list. Officials and other brain-dead people (read: economists) conveniently ignore taxes but the percentage increase in tax rates over the last decade has been staggering. Even if I were to take someone like like Paul Krugman seriously in regards to aggregate demand, the fact of the matter is taxation is killing demand faster than any Fed scheme is increasing it.

      I’ve seen sales taxes increase from 8% to 9.5%. That is a 20 PERCENT increase in sales taxes. Property taxes rising 50% over 10 years in some places means an annual 5% increase. That is inflation in taxes, and those percentages are more than double the CPI measurements.

      If they say “taxes are the PRICE we pay for civilization”, then that price needs to be measured in the price inflation indexes instead of ignored.

    • woodsbp:

      Kreditanstalt, just ask those who do their weekly family shopping what food (incd. potable water) they are buying, and for how many persons. Clearly there will be both regional and national differences, but just report these as is, and avoid aggregating stuff into a meaningless mean. All you have mentioned seem sensible, but ‘taxes’ would pose a difficulty as they may be proportions of income or consumption expenditure. In Ireland we have a 25% VAT rate on many goods! Its 13% on many services. Then we have Excise duties! Then we have income tax! Then we have a Property Tax – paid out of earned income. And soon we will have Potable Water charges, again paid out of earned income. Is it any wonder our economy is headed downhill. Bye, bye demand!

      Funny thing though. Private motor vehicles, have a 100% of import price (or near enough) Registration Tax imposed when the vehicle is first registered for public use. And new motor sales are UP on a year-on-year basis! Whilst retail is still declining.

      Anyhow, PT has mentioned one item that both he and I can agree on – the definition of Inflation (increase in money supply). The unit of currency is a basic or fundamental unit (it is dimensionless). The problem appears to be that you have both regulated and un-regulated entities emitting money (in all forms). That’s a sure path to the debasement of your currency. Prices however, are a derived unit, with the dimensions of units of currency per specified unit of good or service. The good or service may be a singular item, a specific number of items or a weight or a volume. In some instances units of time may also be used. I attempted to explain this difference to some economists, and why using prices as a measure of inflation was unreliable, their eyes simply glazed over. However, when I allowed that inflation was an increase in money supply – I was promptly corrected: “Its an increase in price. Silly!”

      Economic Moral: DO NOT expect economists to deal in any meaningful manner with either of the above. Its below their pay-grades.

      Brian.

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