Posts filed under “Inflation”
Forecasting Inflation? Target the Middle
Brent Meyer, Guhan Venkatu, and Saeed Zaman
The Median CPI is well-known as an accurate predictor of future inflation. But it’s just one of many possible trimmed-mean inflation measures. Recent research compares these types of measures to see which tracks future inflation best. Not only does the Median CPI outperform other trims in predicting CPI inflation, it also does a better job of predicting PCE inflation, the FOMC’s preferred measure, than the core PCE.
At the end of 2012, the Federal Open Market Committee (FOMC) adopted a new guideline for determining when it would consider raising interest rates. What is different about the guideline is that it gives specific thresholds for various economic indicators, which if reached, would signal a change in the Committee’s interest-rate target. These thresholds were spelled out in the meeting statement: “…the Committee…currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6 1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.”
While the unemployment-rate threshold is expressed in terms of current conditions, the inflation threshold is in terms of the outlook for inflation. By specifying the inflation threshold in terms of its forecasted values, the FOMC will still be able to “look through” transitory price changes, like they did, for example, when energy prices spiked in 2008. At that time, the year-over-year growth rate in the Consumer Price Index (CPI) jumped up above 5.0 percent but subsequently plummeted below zero a year later when the bottom fell out on energy prices. At the time, the Committee maintained the federal funds rate target at 2.0 percent, choosing not to react to the energy price spike. Under the explicit inflation threshold, the Committee will not lose its ability to remain forward looking, and will rely on forecasts of inflation.
To help inform those inflation projections, Chairman Bernanke, in a recent press conference, stated that the Committee “will consider a variety of indicators, including measures such as median, trimmed mean, and core inflation; the views of outside forecasters; and the predictions of econometric and statistical models of inflation.” In this Economic Commentary, we highlight the usefulness of trimmed-mean measures (chiefly, the median CPI) in gauging the underlying inflation trend and forecasting future inflation.
Drilling Down to the “Core”
Perhaps the most well-known underlying inflation measure is the “core” Consumer Price Index (CPI).1 This measure excludes the prices of food and energy items because those were the two most volatile categories when the core CPI was conceived. While energy remains the most volatile broad category, food prices have become much less volatile in recent years.
Labor Slack Points to Structural Employment Problem click for larger chart Source: Bloomberg > Nice chart today from Bloomberg Briefs suggesting that we have structural problems in the labor market post-credit crisis. The income gap based on education levels is well established; there is also a low-wage bias in the economy – we seem…Read More
Source: WSJ I wanted to take a moment out this morning to briefly discuss the differences between real, nominal, after tax, and total returns: Why is it that nearly any chart that gets posted — be it index, stock, bond or commodity — invariably results in a knee jerk demand for an inflation…Read More
DJIA – Dow Jones Industrial Average (index) pre- and post- Gold Click for full chart Source: Peter Williams, Advisor Perspectives Interesting look at long term Dow but using the Gold Standard as a dividing line. To be blunt, I am really not sure what to make of it. Was going off of the Gold Standard inevitable, and therefore unimportant? Or was…Read More
I cringe each time I hear some inflationista — you may have met that guy who insisted there was no inflation during the 2000s as the dollar plunged 41% but now sees inflation everywhere — brings today up the Weimar Republic every chance he gets. Here is a look at long term Inflation we spoke…Read More
Happy anniversary Helicopter Ben! It was 10 years ago today that Mr. Bernanke gave his speech titled “Deflation: Making Sure ‘It’ Doesn’t Happen Here” as at the time some “expressed concern that we may soon face a new problem, the danger of deflation or falling prices” as reported inflation rates were low at the time…Read More
Bloomberg Brief points to this report from Carl J. Riccadonna, senior U.S. Economist at Deutsche Bank, looking at the misery index — Inflation + Unemployment. Riccadonna took the usual analysis one step further, applying it to the swing states in the Presidential contest. What did he find: “The following states are “worse-off” based on…Read More
A Little Chronic Deflation
October 13, 2012
One of the questions I (and other analysts) get asked most frequently is whether I think there is deflation or inflation in store for the US. My quick answer is “Yes.” A brief answer is that we are in a deflationary period and have been for over 30 years, but like all cycles it will come to an end. A great deal of the “when” depends on how the US deals with its deficit following the election. If we put the US on a realistic glide path to a balanced budget (over time) then that deflationary impulse will last longer than most observers think, even given QE3+++. If we do not deal with the issue, and try once again to kick the can to the next election, inflation could be a very real problem.
But one of the definitive experts on the question, and someone who has taught me a great deal over the years, is Dr. Gary Shilling, who has literally written the book (several, actually) on deflation. This week he summarizes a recent client letter for our Outside the Box, and I think you’ll will find stimulating. His is not the consensus view, but it’s one we need to understand.
You can subscribe to Gary Shilling’s Insight for the special introductory rate of $275 for Outside the Box readers (email delivery) and get a copy of the full Insight report excerpted here plus a copy of Gary’s latest book, Letting Off Steam, a collection of his commentaries on matters great and small, complex and mundane, serious and frivolous.
Gary will be writing about the details of who will be winners and losers in the Fed’s QE3 program, how overseas economies are faring, and what it all means for US stocks and the American economy. To subscribe to Insight call them at 888-346-7444 or 973-467-0070 and be sure to mention you read about the offer here.
This has been an interesting week. I was supposed to speak at a client meeting for Common Sense Investments at noon on Wednesday in Portland. Kyle Bass of Hayman Advisors was also speaking, so he graciously offered to let me fly with him in his plane rather than catching a redeye the night before. I got up early and made it to the hangar, but the plane had a mechanical problem. A quick call to American Airlines and a mad dash to the airport got me on a scheduled flight that would have gotten me in on time. Except that flight too had issues and the other flights were booked solid. An extremely helpful staff member at American somehow sorted it out and got me onto a full flight (with wifi!) and into Portland in time to let me give a speech as the “closer” for the day. Meanwhile, Kyle was in Chicago and found another way to get to Portland. The other speaker had a personal tragedy to deal with and couldn’t make it; so I called my old friend Ed Easterling, who lives not far from Portland, and he kicked the meeting off with his usual dynamic presentation while the rest of us figured out how to get there.
The next day, the founder of Common Sense Investments, Jim Bisenius, took us to his 36,000 acre ranch (and wildlife preserve) in Eastern Oregon to do a little hunting and fishing. It is a rather amazing place. He is such a gracious host and has a gift for getting people to tell their stories. Kyle brought along a young man who had been Special Operations in Iraq and who now carries around about four pounds of metal from a IED that can’t be gotten out of him. He’s in quite a lot of chronic pain but is rather cheerful and can tell some pretty amazing stories. It makes me humble to realize what sacrifices people make for our freedoms. The courage he and his brethren display on a regular basis is inspiring. I simply stand in awe and gratitude.
I was able to hitch a ride back to Dallas, got in late, got up the next morning, taped videos and read some emails, and then hopped another plane to Houston, where I am getting ready to go to my 40th Rice University class reunion. I am sure it will be another night of old friends and great stories, so I think I will hit the send button and go on to the party. Have a great week!
Your rather amazed at how much fun I get to have analyst,
(Even more amazing is that I get paid for this!)
John Mauldin, Editor
Outside the Box
Seven Varieties of Deflation
By Dr. A. Gary Shilling
Inflation in the U.S. has historically been a wartime phenomenon, including not only shooting wars but also the Cold War and the War on Poverty. That’s when the federal government vastly overspends its income on top of a robust private economy—obviously not the case today when government stimulus isn’t even offsetting private sector weakness. Deflation reigns in peacetime, and I think it is again, with the end of the Iraq engagement and as the unwinding of Afghanistan expenditures further reduce military spending.
Few agree with my forecast of chronic deflation. They’ve never seen anything but inflation in their business careers or lifetimes, so they think that’s the way God made the world. Few can remember much about the 1930s, the last time deflation reigned. Furthermore, we all tend to have inflation biases. When we pay higher prices, it’s because of the inflation devil himself, but lower prices are a result of our smart shopping and bargaining skills. Furthermore, we don’t calculate the quality-adjusted price declines that result from technological improvements in many big-ticket purchases. This is especially true since many of those items, like TVs, are bought so infrequently that we have no idea what we paid for the last one. But we sure remember the cost of gasoline on the last fill-up a week ago.
Furthermore, many believe widespread deflation is impossible and that rampant inflation is assured in future years because of continuing high federal deficits, regardless of any long-run budget reform. And annual deficits of over $1 trillion are likely to persist in the remaining five to seven years of deleveraging, as I explain in my recent book, The Age of Deleveraging. The 2% annual real GDP growth I see persisting is well below the 3.3% needed to keep the unemployment rate stable. So to prevent high and chronically rising unemployment, any Administration and Congress—left, right or center—will be forced to spend a lot of money to create a lot of jobs.
But big federal deficits are inflationary only when they come on top of fully-employed economies and create excess demand. That’s obviously not true at present when large deficits are reactions to private sector weakness that has slashed tax revenues and encouraged deficit spending. Indeed, the slack in the economy in the face of persistent trillion dollar-plus deficits measures the huge size and scope of the offsetting deleveraging in the private sector, as noted earlier.
The deleveraging, especially in the global financial sector and among U.S. consumers, will be completed in another five to seven years at the rate it is progressing. At that point, the federal deficit should fade quickly, assuming a war or other cause of oversized government spending doesn’t intervene. The resumption of meaningful economic growth will reduce the pressure for economic stimuli and rising incomes and corporate profits will spur revenues. Serious work on the postwar baby-related bulge in Social Security and Medicare costs will also depress the deficit.
A decade ago in my two Deflation books, I distinguished between two types of deflation—the Good Deflation of excess supply and the Bad Deflation of deficient demand. Good Deflation is the result of important new technologies that spike productivity and output even as the economy grows rapidly. Bad Deflation results from financial crises and deep recession, which hype unemployment and depress demand.
I’ve been forecasting chronic good deflation of excess supply because of today’s convergence of many significant productivity-soaked technologies such as semiconductors, computers, the Internet, telecom and biotech that should hype output. Ditto for the globalization of production and the other deflationary forces I’ve been discussing since I wrote the two Deflation books and The Age of Deleveraging. As a result of rapid productivity growth, fewer and fewer man-hours are needed to produce goods and services. The rapid productivity growth so far this decade is likely to persist (Chart 1).
While I’ve consistently predicted the good deflation of excess supply, I said clearly that the bad deflation of deficient demand could occur—due to severe and widespread financial crises or due to global protectionism. Both are now clear threats.
My forecast is that the unfolding global slump will initiate worldwide chronic deflation. A number of indicators point in that direction. Sure, much of the recent weakness in the PPI and CPI has been due to falling energy and food prices. Excluding these volatile items, prices are still rising but at slowing rates (Charts 2 and 3). Consumer price inflation is also falling abroad in the U.K. and the eurozone.