In economics we resort to two well criticized methods -- we base forecasts on imperfect theories or take a walk through the data. While inflation theories can be quite complicated, many of us today throw them around like salmon at the Seattle Fish Market. The simpler the better. The economy is stronger than it used to be. Excess capacity is diminishing. Presto, firms can get higher prices for goods and services and inflation is higher. Job done. Way to go dudes.
Sometimes people or what we sometimes refer to as the "street" take these sophisticated theory-based forecasts seriously. Those very important people who comprise the Federal Reserve Open Market Committee (FOMC) take this information seriously and have announced that they have diverted their war against unemployment to a war against inflation. Or in more common layman's language they decided to raise interest rates four times this year.
When the Fed announces a plan to raise interest rates four times in a year that is big stuff. Some emerging markets suffered already as rich folks moved their money back to the USA in anticipation of jucier returns here. Some folks have decided to postpone their purchases of SUVs and garden condos because of higher interest rates. People who worry about inflation are now even more worried about inflation because the Fed would never lie. If the Fed is worried about future inflation then so should they.
While other parts of inflation theory would argue against a sustained rise in inflation, we ignore those irritating little details and sweep them under the rug. I have covered those points in recent posts and don't want to go over that today. Let's just say that most people seem to be clinging to a theory that predicts that strong US growth is going to raise inflation.
Today I want to play games with numbers. I chose to look at recent inflation rates. There are at least as many inflation rate indicators as there are SUVs. So one has to make a choice or write a 700 page dissertation. I chose the measure supposedly used by the FOMC -- the rate of change of the personal consumption expenditures (PCE) deflator. The PCE deflator is very much like its more well-know cousin, the Consumer Price Index (CPI), but it is a lot prettier and dresses better.
There is a version of the PCE deflator that ignores changes in food and energy prices. Food and energy prices are more erratic than a Trump behind a Twitter board. By ignoring F&E in an inflation measure, we focus on things that are less erratic and more sustained. Policy is supposed to ignore all those random fluctuations and focus on more sustained or persistent changes in prices.
I decided that since inflation of the PCE deflator less F&E has been rising for about 7 months -- I would focus on the 7 month annualized change in that index. Those numbers are found in the table below. I am comparing these 7 months changes over 7 month time periods since near the end of the last recession. Thus the table looks at inflation information from 2009 to 2017.
We begin the story by looking at the bottom numbers in the bottom of the table, 2.08 and .04. The 2.08 is the moving average of the inflation rate over the seven months from October of 2017 to May of 2018. Looking up that column you see its the highest number. Thus we see that inflation is higher now. The 0.4 says it was almost half of a percentage point higher than in the previous 7 month period. So that data shows inflation (PCE less F&E averaged over 7 months) is clearly higher.
Does the rest of the table tell us anything else about inflation that could be useful when thinking about the future? Notice that some of the rows of numbers are in red. In those rows the inflation rate in that 7 month period was lower than in the previous 7 month period. Inflation has not gone up linearly since 2009. It goes up and then it goes down. I chose 7 month moving averages because that time coincides with the latest increases in inflation -- and because it is a long enough period to be measuring sustained changes.
The point is that inflation has not sustained itself at higher levels since 2009. It bumps up and then it bumps down. Notice in 2016 there were back-to-back seven month periods when the inflation rose by .29 and then .44 points. Surely inflation was on a tear. But then those two periods were followed by a seven month decline by .83 points. Hmm -- not so much a tear.
I'm not going to bore you with a discussion of all these numbers. But I do think that the two recent bouts of inflation from early 2017 to early 2018 do not prove that inflation is roaring back. Those two periods are not unlike what happened the year before and from what often happens in history after the inflation rate rises for a while.
There is no reason from either data or theory to be sure that inflation will come roaring back like a World Cup player after encountering what appeared to be a life-ending fall on the turf. I am happy the Fed seems to have ended its vendetta against unemployment but that doesn't mean they have to turn their guns on inflation. Just slowly return monetary policy to normalcy. That's all they need to do. Quit scaring the rest of us with your anti-inflation rhetoric. Extreme changes in policy from the frying pan into the fire can cause recessions. Here's a great idea -- let's have a monetary policy that goes from extreme to normal!
Personal Consumption Expenditures Deflator
Less Food and Energy
Annualized Percent Change,
Seven Month Moving Average