Core, and More, Near Zero

David Leonhardt had an interesting post noting how low core inflation had been, in historical context. In fact, many measures of inflation are at very low levels, indeed close to zero.


First, inflation rates for core CPI, personal consumption expenditure deflator, and PPI (finished goods), on a three month annualized basis, are either under 1 percent, or in the case of the PPI, less than zero percent.


core1.gif

Figure 1: Three month annualized inflation for core CPI (blue), core personal consumption expenditure deflator (red), and core PPI (green). NBER recession dates shaded gray. Source: BLS, BEA via FREDII, and author’s calculations.

Second, what about pressures from the labor market? Labor compensation (so, wages and salaries and benefits) is growing at 2 percent (q/q, annualized).


core2.gif

Figure 2: Quarter-on-quarter annualized growth rates for private sector labor compensation (dark blue) and unit labor costs for nonfarm business sector (orange). NBER recession dates shaded gray. Source: BLS, BEA via FREDII, and author’s calculations.

However, the relevant cost of labor to a firm is the compensation cost divided by per hour output, i.e., unit labor costs. In 2010Q4, the q/q annualized growth rate of this series was a negative figure. On a year-on-year basis, it was still below zero, although higher than the trough of -3.5 percent recorded in 2009Q4.


In sum, the inflationary pressures that Representative Paul Ryan worried about on Wednesday do not appear in these statistics. Perhaps that is why he had to resort to a study about the “tooth fairy” compensation rates to substantiate his fears. From Kwak in the Baseline Scenario:

Ryan pointed to numerous studies showing that, despite ongoing economic sluggishness, the Tooth Fairy is paying much more for children’s baby teeth than in past years. In neighborhoods such as Winnetka, Cleveland Park, the Upper East Side, and Palo Alto, children can receive more than $20 per tooth — a dramatic increase from the 25-50 cents that the Tooth Fairy paid only a decade or two ago. In the Hamptons, summertime prices for teeth can easily exceed $100, according to a survey commissioned by the American Enterprise Institute.* Because the Tooth Fairy is able to create money magically, her purchases of unused teeth (with no apparent economic value**) increase the money supply, fueling inflation. Without explicitly accusing Bernanke of participation in the Tooth Fairy’s scheme, Ryan implied that the Tooth Fairy’s higher payouts may be part of the Federal Reserve’s quantitative easing scheme.


Ryan pointed to Tooth Fairy-driven inflation as part of “a sharp rise in a variety of key global commodity and basic material prices” that, he said, threaten to produce higher overall inflation and reduce the value of the dollar. “The inflation dynamic can be quick to materialize and painful to eradicate once it takes hold,” said Ryan, calling on Bernanke to end the quantitative easing program and raise interest rates in order to counteract the expansionary policies of the Tooth Fairy.

By the way, I can’t seem to lay my hand on the actual AEI survey which provided the basis for Ryan’s statement; if anybody has it, please email it, or the link, to me; I need a good laugh.


Update, 12:25pm:: Reader don writes: “…inflation will be muted until it isn’t.” Tautologicslly, that must be true. But, considering about this statement a bit more analytically, I thought it might be useful to see if actual m/m inflation turns on a dime. Well, sometimes it does, but mostly as a blip. When inflation moves from low to a sustained high, rate, it’s usually accompanied by a supply, specifically oil price, shock. Below, I plot m/m inflation from headline CPI and PCE.


core3.gif

Figure 3: Month-on-month annualized inflation, from CPI-all (blue) and personal consumption expenditure deflator (red), calculated as log-differences. Vertical lines at oil price increases (using WTI from FREDII). NBER defined recession dates shaded gray. Sources: BLS, BEA via FREDII, NBER, and author’s calculations.

This suggests to me that those who fear a quick turnaround in actual and expected inflation must be anticipating — either implicitly or explicitly — a supply shock as well.


As of 2/8 (the day before yesterday!), the spread between 5 year constant maturity Treasurys and TIPS implies a 1.95% inflation rate over the next five years.

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42 thoughts on “Core, and More, Near Zero

  1. markg

    The Tooth Fairy inflation is countered by Santa’s deflationary free labor. Come on Ryan, open your eyes to reality!

  2. Rich Berger

    It’s interesting that you would try to distract your readers by referring to a post which attempts to ridicule Rep. Ryan with a completely unrelated fairy tale. You admit that you haven’t seen the survey that Ryan refers to.
    I conclude that even the most knowledgeable observers (including Mr. Bernanke) do not know what the outcome of the Fed’s unprecedented actions will be. Inflation may be muted right now based on current measures, but there is a danger that it could return. For those of us who lived through the Nixon, Ford and Carter administrations, and saw the pain that ensued when inflation was controlled in the Reagan administration, the potential return of inflation is troublesome.

  3. W.C. Varones

    This is like saying, “See, there’s no global warming because it’s snowing in New York.”
    There’s no core inflation because the economy still sucks, labor has no wage negotiating power, and consumers are still very price-sensitive on discretionary items. To extrapolate the current environment to suggest that the Fed’s massive balance sheet expansion doesn’t pose a huge risk is insane. How do you expect the Fed to unwind if the economy ever gets healthy? Even in the absence of a healthy labor market, we are seeing food and energy inflation that is crushing the poor and elderly.
    The Fed has cornered the market for Treasuries like the Hunt brothers cornered the silver market. Congratulations — now what are you going to do with it?

  4. Menzie Chinn

    Rich Berger: Gee, I lived through the “Nixon, Ford and Carter administrations”, too. And also the Kennedy and Johnson administrations as well. I’m not saying inflation can’t be painful (although there is often conflation of inflation with the other effects going on at the same time). It’s just that, unlike previous episodes, we don’t see the inflationary pressures yet. Commodity prices are rising, but there one needs to disentangle relative price increases (due to demand from, say, China), and increases as a harbinger of future general price increases.

    W.C. Varones: I am pervaded by an intense feeling of deja vu. See this post, and our previous exchange about previous episodes of quantitative easing.

  5. Mark A. Sadowski

    The AEI report is inherently biased (as usual). For example it gave headline attention to the price of children’s teeth on the Upper East Side but buried the fact that Tooth Fairy doesn’t even bother to come around inner city Detroit anymore in a barely noticeable footnote.
    Besides, it is well established that the price of children’s teeth is extremely volatile owing to highly inelastic demand by the Tooth Fairy and the erratic supply of children’s teeth due to seasonal factors such as playground fights and jawbreaker consumption.
    And ultimately, according to empirical studies, the pass through from children’s teeth to core inflation is historically nihil mainly due to their low contribution to overall national income and in part due to the fact that children’s teeth have little known real economic value.
    I think Bernanke effectively countered Ryan’s points on this subject when he said this:
    “On the inflation front, we have recently seen increases in some highly visible prices, notably for children’s teeth. . . . Nonetheless, overall inflation is still quite low and longer-term inflation expectations have remained stable.”
    P.S. However, I should note that a Baseline commenter named McMike had this to say about the economic value of children’s teeth:
    “It is well-known that the teeth are harvested from the middle class in exchange for near-worthless fiat coins, and then ground up and served with champagne and caviar for $2,000 a plate at restaurants in the Hamptons, Caymans, and Monaco.”
    I was previously unaware of this fact. Clearly it is the well heeled are the most concerned about inflation in the price of children’s teeth.

  6. ppcm

    Inflation expectation is not always “waiting for Godot” as testified by the inflation recorded by England through BOE record.
    Bloomberg By Svenja O’Donnell – Feb 10, 2011
    King Faces Ticking Clock on Interest Rates as Inflation Soars.
    Beyond the Central banks statistical exercise of collecting opinion on “inflation expectation” in progress,may we look at the empirical statistical data of
    S FIsher,Chin Te Liu,Ruilin Zhu (When can we forecast inflation?) Econbrowser core at zero.The study is not ascertaining a complete grasp by central banks of the so called inflation expectation.
    May we look as well to the inflation forecast error panel of the ECB monthly bulletin January 2011 (P49).It is worth a meditation, as consensus is proved to have always underestimated inflation that means consensus is,was, wrong.
    The fed funds effective rates and the implied forward rates through forward future rates are the tale of two expectations.
    Are they any studies available,dealing with the case of a country s central bank, that can no longer export inflation through the expansion of its balance sheet? or is it a story in the making?

  7. aaron

    Thrift burnout. Companies acting on a temporary bump in sales due to thrift burnout. People cut into saving this season for non-discretionary expentiture increases and simple loss of will power. These saving will need to be made up this spring/summer/fall.

  8. kharris

    R. B.,
    To make the historical context more relevant to the issue at hand, I think you should stick to “the Burns administration and the Miller administration” and then “the Volcker administration”.

  9. kharris

    Comparisons between global warming and inflation are not all that apt. Global warming, understood in the simplest way, is a rise in average air and ocean temperature around the globe. We can measure and find a rise in average temperatures right now. The argument (largely fake) is over whether it can be blamed on the build-up of CO2 and other greenhouse gasses. Consumer price inflation, understood in the simplest way, is a general acceleration in the price of consumer goods and services. We can measure now and find that there is no general acceleration in prices of consumer goods and services. The argument is over whether the Fed’s bulging balance sheet will lead to inflation. But you see the dissimilarity – a real, measurable rise in global temperatures against no measurable acceleration in prices at the consumer level.

  10. madmikefisk

    I don’t see what core CPI has to do with inflation at all… inflation is a rise in overall price levels. Removing elements from an analysis of price levels is giving you an incomplete picture, as price volatility in the excluded elements may affect demand and production decisions across the economy to compensate for this fact.
    Also, to say “there’s no inflation” by construction of a price index that conveniently ignores the two things that happen to be rising the fastest in price is disingenuous at best and malicious at worst.

  11. Jeff

    madmikefisk: Core CPI has everything to do with inflation. The reason one removes certain elements from a price index is that price of any good can move as a result of two very different factors, (1) Shifts in the supply/demand of that particular good or (2) changes in the value of the good relative to the countries monetary unit (i.e. dollars).

    One thing to notice right away is that changes due to (1) are likely to be specific to the individual good and changes due to (2) are likely to be economy-wide, usually as a result of changes in the money supply.

    By controlling the money supply, the Fed is responsible for managing only economy-wide price levels. The Fed is NOT responsible for managing the prices of individual goods. Nor is the Fed responsible for making sure the price of goods consumers typically buy stay low. This is a subtle but very important point and is often conflated by people like Ron Paul who want to make their point that the Fed is doing something they don’t like.

    Now, when the price of a good changes we don’t know for sure if its due to (1) or (2), but we do have some inclination that certain goods are more likely to see a change from (1) than from (2). Food and energy fall into this category. Their prices will often change rather dramatically from changing crop yields, increasing demand from rapidly developing countries, political instability in energy exporting countries, etc. These are factors that the Fed does not want to try and fight against. These are normal supply and demand factors that ought to be realized in a capitalist economy.

    Thus if one wants to design a price index that most accurately tracks (2) and ignores (1), one should exclude goods like food and energy, even though we all agree they are important goods to consumers.

  12. don

    The issue is whether, if forced to react quickly to a change in expectations, the Fed would be able to stop inflation from taking hold. It’s massive balance sheet may bring fears that it won’t be able to. Inflationary expectations are muted now, but that doesn’t mean they will stay that way, any more than a rising stock market can ensure that equities aren’t overpriced: inflation will be muted until it isn’t.

  13. Barkley Rosser

    Rich,
    It is highly likely that Ryan’s data is accurate from the cited study. But Mark S. implies the point. The areas studied are very high income ones, and we know that there has been a massive increase in income inequality in the US, with a massive increase in incomes at the top, while the rest have stagnated. So, that very wealthy people are giving their kids more money for their teeth does not say doodley-squat about broader price tendencies in the economy, much less what teeth are going for in not-so-wealthy neighborhoods. It is just goofy nonsense.

  14. mp

    “By the way, I can’t seem to lay my hand on the actual AEI survey which provided the basis for Ryan’s statement; if anybody has it, please email it, or the link, to me; I need a good laugh.”
    It isn’t funny. Those people are running this country.

  15. Steve

    It cost me $50.00 to tank up yesterday. Last year it cost me $40.00. That is rather high inflation. I remember you telling me I was crazy on food prices….hmmmm let’s see, 120 days ago the same grocery list was 8% less than last Monday. Looks like inflation to me. Shall we talk propane, up 10%. Cotton? Wholesale price up over 100%, how much it affects my tee shirts and my white tighties, unknown, but they are going to go up! However, the temperature was one degree below the 100 year average this year in my part of Wisconsin! Hey, didn’t you have a blizzard there last week Menzie?
    The only thing not rising is the $$$’s in my wallet, the value of my house and the propane in my tank!!!!

  16. 2slugbaits

    Menzie I believe Rep. Paul Ryan was referring to the Heritage Foundation study. It’s one of their better reports.
    madmikefisk I don’t see what core CPI has to do with inflation at all… inflation is a rise in overall price levels.
    The Fed is not worried about price changes that don’t have staying power. Gas prices jump up one month and don’t do anything the next, or perhaps they go down the next month. The point is that price changes in volatile commodities do not tend to persist beyond a one month shock. Put another way, they don’t carry any momentum into the next month. But if core inflation starts to rise, that means higher prices one month become good predictors of higher prices the next month; and people start to act on those expectations. Core inflation happens because the expectation of higher prices gets institutionalized in commodity and labor contracts, and once institutionalized it is very hard to wring out core inflation. Think of it this way. Food and price inflation is like an Indy race car…it quickly accelerates and deccelerates, but because it is light it doesn’t carry a lot of momentum. Compare that to a freight train that is slow to get going but once it gets going it’s hard to slow down. The Fed isn’t worried about the Indy car, but very worried about the freight train. The Fed’s immediate concern is that the freight train is slowly losing speed just as it’s coming upon a hill. Right now we’re experiencing disinflation (i.e., a falling rate of core inflation), but with a near zero core we are perilously close to actual deflation.

  17. Menzie Chinn

    Steve: Well, I don’t recall calling you “crazy”. According the the Philadelphia Fed, Men’s and Boy’s apparel actually fell 4.3% on an annualized basis in December. If you were an alcohol drinker, you’d be in luck; that fell 14% on an annualized basis. Doesn’t mean prices won’t go up in the future (and the aggregate CPI is rising — I didn’t deny that). But then I didn’t hear anything from you about the 20% drop in the CPI-all (annualized basis) in November 2008 (preceded by a 10% fall in October, and succeeded by a 9% fall in December).

  18. 2slugbaits

    Steve The only thing not rising is the $$$’s in my wallet
    If the $$$’s in your wallet are not rising, then you might want to ask yourself how it would be possible for there to be sustained inflation? Inflation only becomes a serious problem worthy of the Fed’s attention when it becomes a self-sustaining force, and that can only happen when inflationary expectations get locked into unit labor costs. And as Menzie’s Figure 2 shows, there is no upward pressure on labor costs.

  19. techy

    finally a blog where most people know what they are talking about.
    I have tried and tried but unable to comprehend how high consumption of oil and say commodities by china and india is due to FED’s QE
    nobody seems to ask the question, what if the global consumption is so high now…that supply cannot catchup, do we push USA into another recession with the assumption that it will cut down global consumption of commodities??
    what if the food price increase is only because of bad supply(bad harvest) or say increased demand due to increase in population?? what does that has to do with loose monetory policy in USA??

  20. aaron

    Steve, if you bought the same things, they might cost more. But recently food has come down in price in the US ([OT: substitution was easy, cheap, and usually didn't reduce quality in the early 2000s] I don’t think that’s so simple/likely now). I’m taking the BEA at its word since I don’t as shop much anymore (I did well with ramen and cabbage last year and the occassional steak or salmon and vegetables. This year I’ve gone back to more cereal,dairy, fatty meat, and occasional vegetables, but I’m getting fat).
    Last fall I took a look at the BEA income and expenditures data. Healthcare was the big disposable income eater this decade. Housing (including utilities) was about second. Gasoline was third. Food has been pretty stable this decade (I think mainly due to subsitution in recent years).
    The big deal was that expenditures I would consider non-discretionary (healthcare, gasoline, rent/housing + utilities, etc.) left disposable income down (food was pretty stable–likely due to subsitution). The past few years, savings to disposable income (before those non-discretionaries) had tried to reach 6%. It dropped this winter for the reasons I suggested in comments above.
    Foreclosures have accelerated recently (I think this is a good thing). Also, interest rates have increased. These things may bring house prices down (good for home builders and property managers with cash). This will relieve the housing “non-discretionary” expense, but foreclosure overhang will delay the convergance of property value * interst with rent. That’s bad. It also eats up income for people who are unwilling to walk away from their mortgages though they logically should.
    Banks are seizing more propety though, which I think is a good sign since they will probably put it to the market finally. This will speed things up.
    However, if income doesn’t grow faster than expenses, I expect to see more default later this year and I don’t think the banks expect this.

  21. aaron

    TSB, the same thing for deflation. And, there’s no upward pressure on labor costs. But that seems to be changing (unit labor cost seems to be increasing again, but total comp is flat).
    The current health care legislation did a lot to increase demand, but did very little to increase supply (recent history has shown that price has not increased supply much).
    How much cash is landing in people’s hand?

  22. aaron

    techy, good questions. You are likely mostly right about QE and oil, but QE has allowed people to test those prices (push them up) with little risk. Unfortunatly taking it way will not bring them down.
    For the other question, those are likely due to bad harvests (and a little to increased population). I’m very unsure of what that has to do with US monetary policy, but as a net exporter of food, it would be beneficial. It’s all relative. What’s the net effect.

  23. aaron

    (decreasing the value of the dollar increases consumption of oil by china, india, etc.)
    As for USA recession, I wouldn’t rule that out.
    This is mainly faith/hope/specutlation on my part, but I think supply is much higher than we believe. It’s constrained by regulation/bureaucracy, tech, and game theory.
    I think hoarding (in ground) is a powerful signal to the rest of producing nations that production will not increase and that alternatives are not viable this half of the centrury.

  24. flow5

    Income velocity & the transactions velocity have moved in opposite directions during the Great Recession.
    A dollar bill which turns over 5 times can do the same “work” as one five dollar bill that turns over only once.
    As Dr. Milton Friedman said it best: “inflation is always and everywhere a monetary phenomenon”.
    Bernanke has just blown a gasket.

  25. Michael Cain

    As Dr. Milton Friedman said it best: “inflation is always and everywhere a monetary phenomenon”.
    What Friedman, conservatives in general, and the contemporary Republican Party (along with elements of the contemporary Democratic Party) don’t get is the distributional effects. If the Fed creates a new trillion dollars and gives it to one person (I volunteer if they want to conduct the experiment), the places where it can create inflation are limited. I can’t buy a trillion dollars worth of consumer goods this year; but I can buy a trillion dollars worth of financial assets.
    To create a broad general inflation requires that the newly-created money be broadly distributed. Note that every simple example used in economics instruction has that assumption built in, but it’s never (in my experience) pointed out.

  26. Ricardo

    Here you will find a CNNMoney link to Ryan’s questioning of Bernanke for those who want to make an unfiltered judgement.

  27. Anonymous

    If Bernanke is faced with 9% unemployment and 9% inflation what will he do with interest rates?
    This is what supply side economists have asked for almost 50 year. Usually, a FED chairman will choose to “deal” with unemployment before a stable dollar and as in the Carter administration inflation becomes out of control.

  28. Get Rid of the Fed

    “According the the Philadelphia Fed, Men’s and Boy’s apparel actually fell 4.3% on an annualized basis in December. If you were an alcohol drinker, you’d be in luck; that fell 14% on an annualized basis.”

    Nonalcoholic beverages and beverage materials -14%

    Alcoholic beverages +1.1%

  29. Get Rid of the Fed

    “This suggests to me that those who fear a quick turnaround in actual and expected inflation must be anticipating — either implicitly or explicitly — a supply shock as well.”

    How will china escape its “dollar trap”?

    What happens if china starts selling to Africa, Latin America, and the rest of Asia instead of the USA? Will there be fewer goods here, less need to buy dollar denominated assets, and exchange rate rises leading to some price inflation in tradable goods and higher interest rates?

    Similar situation for oil?

  30. Get Rid of the Fed

    Michael Cain said: “To create a broad general inflation requires that the newly-created money be broadly distributed.”

    Do you want that newly created money to be currency or debt?

  31. 2slugbaits

    flow5 As Dr. Milton Friedman said it best: “inflation is always and everywhere a monetary phenomenon”.
    Except of course that in this case we’re talking about the absence of inflation. And if Friedman were alive today he would be supporting QE2.

  32. 2slugbaits

    Anonymous
    If Bernanke is faced with 9% unemployment and 9% inflation what will he do with interest rates?
    This is what supply side economists have asked for almost 50 year. Usually, a FED chairman will choose to “deal” with unemployment before a stable dollar and as in the Carter administration inflation becomes out of control.

    Ugh. First, if inflation was running at 9% then it’s a safe bet that we wouldn’t be looking at a ZIRP condition, so the premise of your question is strong evidence that you don’t understand the macroeconomics here.
    Second, go check the BLS data. Unemployment during the Carter years was very low. We certainly had stagflation, but that does not mean we had a lot of unemployment. See the difference?
    Finally, if you want to talk about actual supply side policies (as opposed to the fake “Supply Side for Dummies” stuff that Reagan tried to peddle), then supply side policies might make sense in a world of 9% inflation & 9% unemployment because the source of unemployment is probably due to an aggregate supply shock. But all that is irrelevant because today’s problem is not constrained aggregate supply, it’s weak aggregate demand. And in a liquidity trap the aggregate demand curve slopes the wrong way, so in that case supply side policies are really stupid because pushing out the supply curve actually reduces total output. [If you don't understand the part about the upward sloping AD curve, then consult James Tobin...he wrote about it and Krugman has recently picked up on it.]

  33. don

    There seems to be a very real disconnect for those who believe inflation is not inevitable. A large part of our *voting* population believes Medicare is not a government run social program, and we have politicians willing to take advantage of such confusions. This, combined with the unwillingness of the American voters to accept unpleasant truths (from the inability to institute carbon taxes, to the use of tax breaks in place of much more effective fiscal measures to combat unemployment), bodes poorly for the notion that these same voters we will rediscover fiscal restraint when the economy ‘recovers.’

  34. 2slugbaits

    don There seems to be a very real disconnect for those who believe inflation is not inevitable.
    I don’t know what you mean here. And I’m assuming that by “inflation” you don’t just mean some steady low level that is within the Fed’s target. I assume you mean something like double digit inflation. My confusion is with your use of the word “inevitable.” Do you mean “inevitable” in the sense that earthquakes and meteor strikes are inevitable? Okay, in that sense I suppose inflation is inevitable. The world is stochastic, not deterministic. Eventually there will be some Fed miscalculation, or perhaps the GOP will succeed in shaping a less independent Fed that bends to the will of crackpots like Ron Paul. But just because inflation may always be a monetary phenomenon, that does not mean that a monetary phenomenon alone is a sufficient condition to generate accelerating rates of inflation. The Fed has to do more than just double the monetary base to create inflation; the public has to also believe that the Fed will double it next year, and the year after that, and the year after that. A one off deal does not mean inflation is inevitable.
    As to the misunderstandings of many of the posters here (and elsewhere), I think the biggest misunderstanding is about the different purposes behind headline CPI and core CPI. Headline CPI is useful as a measure of change in welfare. So if you want to ask whether or not you are better off in real terms than you were last year, then headline CPI is an appropriate corrective lens. But the Fed isn’t in the business of retrospectively looking back at the welfare of urban consumers. The Fed cannot change whatever the headline rate was last month. That’s already in the books. What the Fed can do is to sort through the noise and try to find signals that will tell it what headline CPI might look like over the next year or so. And for that you want to use something like core CPI because it filters out the noise and better captures price inertia. The Fed is in the business of looking forward, and that’s why they use core CPI or core PCE. It’s not that headline CPI is meaningless, as some here seem to believe Menzie is saying, it’s that headline CPI is not a useful predictor of future inflation. It is, however, very useful as a way to retrospectively capture changes in consumer welfare. Unfortunately, too many people here think about their personal experience of welfare changes and extrapolate that personal experience into the future and treat that as a prediction of future inflation.

  35. Anonymous

    Looking at the here and now is a fool’s errand. You have to make an educated guess at inflation in the future resulting from current policies. Unwinding massive quantitative easing isn’t as easy as you think (as we saw in 2004) and monetization of the deficit is not something you can really control.
    Have you looked lately at the TIPS spread and the 5yr/5yr Forward spread?
    They have all risen about 60 bps since September of last year, and these measures tend to underestimate inflation expectations because of the liquidity premium of treasuries.
    I’m not suggested we have unanchored inflation expectations, but the outlook for inflation in the next five years is above the Fed’s policy limits. Bond futures are telling us that interest rates will be rising by year-end and rising further in 2012, so expected Fed policy is already baked into inflation expectations.
    About 30-50% of the increase in long bond yields is explained by rising inflation expectations.
    We can also expect that tightening monetary policy in China may raise long-term yields. That could be good news for our trade balance but bad news for our debt service payments and inflation.
    Personal anecdotes about rising food and fuel prices are a poor way to gauge inflation, but commodities and high-risk assets are prone to bubbles from prolonged low interest rates. There is a search for yield and a flight toward risk. So, indirectly, Fed policy IS having an impact on commodity prices although general inflation is low. Ignoring rising prices in commodities and financial markets is foolish. Greenspan made this mistake in 1996 and again in 2004-2005, and many other people are making the same mistake now.

  36. flow5

    “if Friedman were alive today he would be supporting QE2″
    No doubt. But “inflation” is already accelerating, & long-term money flows have bottomed. So no matter how you now define it, prices are rising.
    As for QE2, financial investment is not the solution to job growth.

  37. 2slugbaits

    Anonymous
    Unwinding massive quantitative easing isn’t as easy as you think (as we saw in 2004)
    I wasn’t aware of any QE back in 2004. My recollection was that it was monetary policy the old fashioned way. And the larger macroeconomy was in a different place. Should the Fed have raised the FFR a bit…perhaps, although raising taxes to pay for the war and the structural deficit probably would have been a better approach.
    Have you looked lately at the TIPS spread and the 5yr/5yr Forward spread?
    I’ve looked at the 10yr spread and the gap has been pretty constant, with perhaps a very slight widening depending on the start/stop dates that you select. So let’s delve a little deeper into this. TIPS interest rates have started to tick upwards over the last 4-5 months. You could interpret this as either an expectation of stronger economic growth or an increase in the likelihood of default. I think the former explanation is more plausible, how about you? Now as to the very slight widening of the gap between TIPS and unadjusted securities, I interpret this as being an expectation of a return to normal levels of inflation. In other words, the extremely narrow gap that we saw recently was an unhealthy signal because it signaled that the market saw continued disinflation and perhaps deflation far out into the future. That’s not good. The goal is not to have zero inflation, it’s to operate within the Fed’s target zone, and lately we have clearly been running below the Fed’s target zone.
    As I said above, when people talk about future inflation as a problem I’m assuming that they are not referring to a steady low level of inflation. Hopefully we’ll soon return to those happy days of 2.5% core inflation. Inflation is only a problem when it becomes accelerating inflation, and given the amount of slack in the economy right now and given that no one believes QE2 is permanent, it’s hard to see how 1970s style accelerating inflation is a problem worth worrying about.
    Ignoring rising prices in commodities and financial markets is foolish. Greenspan made this mistake in 1996 and again in 2004-2005, and many other people are making the same mistake now.
    But seeing inflation where there isn’t any is also foolish and a lot of people made that same mistake over the last two years. Rep. Eric Cantor lost his shirt financially because he bet a lot of his own money on inflation being just around the corner. Oh well, at least he puts his money where his mouth is…too bad he doesn’t have a smarter mouth. And Greenspan also saw inflation where it wasn’t back in June 2000 when he went to the well once too often and precipatated the 2001 recession.

  38. MarkS

    Menzie-
    I share your mirth at the specious anecdotes that pass through Paul Ryan’s lips on occasion. The tooth fairy story is a classic, that I’d bet Ryan was enunciating tongue in cheek. Despite the frequent logical consistencies of Ryan, (de rigour in political speech), I applaud his willingness to address the unsustainability of continuous deficit spending and credit expansion in excess of civilian production in America.

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