Is Inflation Back?

Is inflation coming back? Are hoola hoops returning? I don't really know since I still don't know how to predict the future. But people want to know answers to these kinds of questions so we devise ways to think about the future. One way is to hire a psychic or you could buy a Ouija Board.

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

		7 Mo
		Avg	Change
2009	Aug	1.46
2010	Mar	1.57	0.11
2010	Nov	0.89	-0.68
2011	May	1.8	0.91
2011	Dec	1.7	-0.1
2012	Jul	1.93	0.23
2013	Feb	1.59	-0.34
2013	Sep	1.25	-0.34
2014	Apr	1.78	0.53
2014	Nov	1.43	-0.35
2015	Jun	1.3	-0.13
2016	Jan	1.59	0.29
2016	Aug	2.03	0.44
2017	Mar	1.2	-0.83
2017	Oct	1.68	0.48
2018	May	2.08	0.4

Inflation: Viva la Difference?

Venezuela has been in the news a lot lately. While the news has covered a lot of different issues from food shortages to returned prisoners, I was very impressed with their inflation rate. According to the International Monetary Fund, the inflation rate of Venezuela in 2017 was 2,818.4 percent*. That got me wondering about the state of inflation around the globe. The US has experienced remarkably low inflation in the past decade; it came in at 2.1 percent in 2017. Are most countries like the US or more like Venezuela?

While my goal today is less about policy and more about simple comparisons, it won’t hurt starting out with a little background about inflation, its causes, and its consequences. Inflation is a straightforward concept. It is a macro concept that measures how much prices are changing in a nation. It is calculated by averaging together the prices of a bunch of things we usually buy. The Consumer Price Index is one of many measures of inflation. It looks at changes in the prices of the goods and services we most often purchase. Thus, we often speak of it as a measure of the nation’s cost of living.

When the cost of living is rising faster than our incomes, the buying power of our income falls. This raises caution because it means people find it harder to continue buying the same quantity/quality of goods and services. Some people think a little bit of inflation is good but when it reduces our ability to buy we get concerned. You could think of this in terms of inflation stages. Low inflation is okay and might be beneficial as most of us look forward to our wages rising, and firms often find life easier when their prices are increasing. When inflation gets higher, we begin to worry about purchasing power. When inflation accelerates even faster, we get even more concerned. At even higher rates, it creates additional concerns if it causes trading partners to shun our high-priced goods. It would cause alarm if it was a signal of deeper economic problems and foreigners decide to stop investing in our country.

With that brief background we wonder what was going on with respect to inflation in the world in 2017. The table below contains inflation information I took from the IMF. The information is divided by the six regions of the world. These regions account for 150 countries and sub-regions.

The first column contains the name of each region. Look below the table for the full region titles. In the ( ) is the number of countries and sub-regions reported in each region. The Advanced Countries include 40 countries/sub-regions.

The third column in the table labeled AVG gives the average inflation rate for all the countries in that region. The table is ordered by these inflation rates. In 2017, the Advanced Nations' inflation rate averaged 1.7%. The region with the highest inflation rate in 2017 was the Middle East. Those 23 countries averaged 7.2% inflation in 2017. 

Clearly, from the table, emerging markets experienced significantly higher inflation than that of the Advanced Nations.

The second (Low or L) and fourth columns (high or H) show you the range experienced by countries in each of the regions. One Advanced Nation experienced deflation in 2017 of 0.5%. The highest inflation rate experienced by any Advanced Nation in 2017 was 3.8%. Notice the range of inflation rates for Emerging Asia – from 2.2% deflation to 7.5% inflation.

The number that sticks out the most in the table is the 2,818.4% inflation rate experienced by Venezuela in Latin America. The 30% rate for the Middle East came from two countries: Egypt and Libya.  

The fifth column in the table is a measure of the inflation dispersion within each region. It tells you how many of the countries in that region had inflation rates of 3% or less. Of the 40 advanced countries, 93% had inflation rates of 3% or less in 2017. In contrast, only 15% of the CIS countries experienced 3% inflation or less. Despite the 12% inflation rate of Turkey, 92% of the countries in Emerging Europe had inflation of 3% or less.

These numbers raise more questions than we can possibly answer today. They communicate the idea that inflation in 2017 was experienced in highly varying degrees around the world. In some countries, prices fell while they were rising by almost 3,000% in others. Despite world trade and despite globalization, there is no such thing as a common inflation experience. While a casual viva la difference might sound like fun, the underlying point is that inflation has consequences, and both the causes and consequences of inflation are alive and well. We breathe easier in the USA with such low inflation. But the world in 2017 shows that when the right mistakes are made, damaging inflation could be closer than you think. 

           Inflation Rates, 2017

Regions             L      Avg     H          3%

Advan (40)     -0.5     1.7      3.8        93%

Em Asia (30)  -2.2     2.8     7.5         56%

LA & C (32)   -0.2    4.1** 2,818.4   53%

CIS (13)           2.5     4.7     13.7       15%

Em Eur (12)    0.7     6.8     11.9       92%

Mid East (23) -1.0     7.2     30.0       48%

*The data I used for this post came from the IMF’s World Economic Outlook for April 2018. More precisely, they come from Appendix Tables A6 and A7. The inflation measure quoted here is the annual percentage change in the Consumer Price Index. The complete names for the regions are:

Advanced Nations

Emerging and Developing Asia  - China, India Vietnam and others

Latin America and the Caribbean – Argentina, Brazil, and others

Commonwealth of Independent States  -- Russia and others

Emerging and Developing Europe – Turkey, Croatia, Hungary, and others

Middle East, North Africa, Afghanistan, Pakistan – Egypt, Saudi Arabia, and others

**The 4.1% average for Latin America excludes the very high inflation rates for Venezuela and Argentina

Are Wage Gains Ready to Skyrocket?

Most people take for granted that wages have shown lackluster growth over the last 20 years or so. So I put my data cap on and starting looking at numbers. My first takeaway is that there are way too many numbers. We might want to know how wages have kept up with productivity. That seems reasonable. But then one needs to find companion series for wages and productivity, so we can compare apples with apples. That can be done but do we want to compare these series for all workers? For all manufacturing workers? For medium-income workers? Over how many decades?

Another comparison of wages could focus instead on how wages changed compared to prices – that is, did wages keep up with inflation? Again, there are many indicators from which to choose – various measures of wages and even more measures of inflation. To makes matters even more challenging – some of the series go back to 1929 while others just got started in 2006.

What I am saying here if it isn’t obvious is that it is time for a nice cold JD. It is also time to make some decisions. No matter which choice I make some of you will want to scold me. But I made a decision anyway. I decided to focus on the years from 1968 to 2017. Going back to 1968 means we have a rich enough data set so that we can put today’s low inflation numbers in perspective with past times when US inflation was higher. I also decided to use the CPI as my inflation variable. Earnings of Production and Nonsupervisory Workers in the Business Sector is my measure of wages.

What I examined is how earnings kept up with inflation during the past half-century. To do this I calculated three times series –  % change in earnings (Edot), % change in prices (Pdot), and % change in the buying power of the earnings (calculated as the first series minus the second one (Edot minus Pdot)). For example, in 1970 the % change of earnings was 6.1%. Prices rose by 5.6%. Therefore the buying power of the earnings rose by 0.5% (6.1-5.6) in 1970. 1970 is an example of a year when earnings did quite well. The wage increase of these production and nonsupervisory workers was larger than the increase in the cost of living.

As I look down my table (below) I notice there are lots of years when the buying power of earnings was positive while there were also years when workers did not keep up with inflation (buying power of earnings was negative). When the buying power of earnings was negative – it meant that workers were getting behind – and that they might at some point want to catch up. 

The earnings buying power went down considerably from 1973 to 1975 and then again from 1978 to 1981. In those years inflation was hitting double digits and despite some good years of earnings growth – these earnings just couldn’t keep up with inflation. In 1980 earnings rose by almost 9% but since inflation was 12.5% workers fell behind. And strangely enough, it was not until 1995, after the inflation rate had fallen considerably that earnings began rising faster than inflation. The years 1995 to 2002 were catch-up years. During those years earnings rose a total of about 10 points more than inflation.   

Between 2003 and 2012 there was no real pattern. But then between 2013 and 2017 there was a very clear pattern – and brace yourself for this – wherein inflation  generally stayed below 2% per year – wages of production and non-supervisory workers were rising by about 2.4% per year. Thus, earnings were catching up as the buying power of earnings increased. 

There are lots of ways to go from this point. But let’s not forget one thing. While workers always want higher wages – the thrust for higher wages is often driven by how far wages stretch to buy goods and services. This data suggests that while there have been times when the buying power of the wages declined (in the 1970s and then from the mid-80s to the mid-90s) – the last 15 years cannot be classified as a time when inflation robbed workers of their buying power. Especially the last 15 years show just the opposite. Workers might not love the size of their wage increases – but these increases have been well above the inflation rate. And therefore, there is no clear pent-up explosion of wage increases looming around the corner.

As I said above, there are lots of ways to go from here. I am not saying that all workers are just fine. I am not saying there are no labor market issues to deal with. What I am saying is that the rate of growth of earnings compared to the cost of living is important for understanding future wage and price growth. The earnings of production and nonsupervisory workers in the USA might not be growing rapidly but they have, of late, been growing faster than the cost of living. That needs to be factored into our forecasts for the future. 

Table

	Earnings			CPI						Edot -
Year	Dec			Dec		Edot		Pdot		Pdot
1968		3.11	35.5
1969		3.30	37.7		6.1		6.2		-0.1
1970		3.50	39.8		6.1		5.6		0.5
1971		3.73	41.1		6.6		3.3		3.3
1972		4.01	42.5		7.5		3.4		4.1
1973		4.25	46.2		6.0		8.7		-2.7
1974		4.61	51.9		8.5		12.3		-3.9
1975		4.87	55.5		5.6		6.9		-1.3
1976		5.23	58.2		7.4		4.9		2.5
1977		5.61	62.1		7.3		6.7		0.6
1978		6.10	67.7		8.7		9.0		-0.3
1979		6.57	76.7		7.7		13.3		-5.6
1980		7.13	86.3		8.5		12.5		-4.0
1981		7.64	94.0		7.2		8.9		-1.8
1982		8.02	97.6		5.0		3.8		1.1
1983		8.33	101.3		3.9		3.8		0.1
1984		8.61	105.3		3.4		3.9		-0.6
1985		8.87	109.3		3.0		3.8		-0.8
1986		9.01	110.5		1.6		1.1		0.5
1987		9.28	115.4		3.0		4.4		-1.4
1988		9.60	120.5		3.4		4.4		-1.0
1989		9.98	126.1		4.0		4.6		-0.7
1990		10.35	133.8		3.7		6.1		-2.4
1991		10.64	137.9		2.8		3.1		-0.3
1992		10.90	141.9		2.4		2.9		-0.5
1993		11.18	145.8		2.6		2.7		-0.2
1994		11.47	149.7		2.6		2.7		-0.1
1995		11.81	153.5		3.0		2.5		0.4
1996		12.25	158.6		3.7		3.3		0.4
1997		12.76	161.3		4.2		1.7		2.5
1998		13.22	163.9		3.6		1.6		2.0
1999		13.70	168.3		3.6		2.7		0.9
2000		14.29	174.0		4.3		3.4		0.9
2001		14.75	176.7		3.2		1.6		1.7
2002		15.21	180.9		3.1		2.4		0.7
2003		15.47	184.3		1.7		1.9		-0.2
2004		15.86	190.3		2.5		3.3		-0.7
2005		16.36	196.8		3.2		3.4		-0.3
2006		17.05	201.8		4.2		2.5		1.7
2007		17.69	210.0		3.8		4.1		-0.3
2008		18.38	210.2		3.9		0.1		3.8
2009		18.84	215.9		2.5		2.7		-0.2
2010		19.22	219.2		2.0		1.5		0.5
2011		19.56	225.7		1.8		3.0		-1.2
2012		19.89	229.6		1.7		1.7		-0.1
2013		20.34	233.0		2.3		1.5		0.8
2014		20.73	234.8		1.9		0.8		1.2
2015		21.25	236.5		2.5		0.7		1.8
2016		21.78	241.4		2.5		2.1		0.4
2017		22.31	246.5		2.4		2.1		0.3