Fake OR Real Inflation?
A: Which do you think we have? It is very hard to argue that the reason we have a headline data report and a core data report is to eliminate the volatility that food & energy prices have on the results. With wild swings, comes inconsistent data that is hard to draw conclusions from. In addition, as food & energy prices RISE, they are considered to be TRANSITORY (temporary) & SELF LIMITING (inhibiting it's own growth). But what happens when food & energy prices go only up? There is no temporary and there is no self-limiting! Should we still strip out these inflation items as the fed sets policy?
Its the great debate. Is their inflation or not? I have asked so many people about this and every single one of the answers was..."YES, we have inflation!" After all, have you noticed food prices, housing costs, gas prices rising or falling in the past 3-4 years?
FANTASY - Core economic datasets have shown inflation pressures to be moderating. These reports exclude food & energy prices because of their volatile up and down trading nature. The fed is thought to favor these core reports in their inflation targeting.
REALITY - Headline inflation has not been moderating and is the same report as the core plus the effect of food & energy prices. If you look at the chart below (courtesy of The Big Picture where Barry Ritholtz discusses here, here, and here his feelings on the topic), you will see the actual relationship between the core rate of CPI inflation and the headline rate of CPI inflation (the rise shows the widening spread between the two measures as headline inflation shows reality and core inflation excludes food & energy)
FANTASY - House prices across the nation have fallen, so affordability has risen significantly and monthly living payments have been declining!
REALITY - 
Well what about the rise in borrowing costs since the peak of the nation wide housing market back in late 2005 or so. What about the re-pricing of risk that has occurred in the mortgage markets and the subsequent rise in lending rates, especially for not perfect credit borrowers? What about the rise in heating and maintenance costs? Don't these increases in costs counter any reduction in monthly payments from a lower loan amount? To the right I have a chart (via bankrate.com) showing the rise in 30YR Jumbo Mortgage Rates Nationally since early 2005 (notice the rise in borrowing costs since mid 2005, as national housing slump began - rates are even higher today for lower credit borrowers due to credit crunch)
This argument is important because monetary policy is going to be set based on the presence or absence of inflation! I live in the real world. I pay my bills. I buy food and pay my own health care costs. I also pay rent. It is without a doubt a more expensive place to live my daily life in.
However, I can buy any of the following today for LESS MONEY: flat screen tv's, cars, ipods, compact discs, clothes from Gap, a dvd, a vhs (if you can find one). So I said "Hey Lama, HEY, how about something, you know, for the effort", and all of a sudden I have total consciousness coming to me on my death bed.....which is nice. I digress.
Is inflation a rise in living costs and goods needed to live OR a rise in wage inflation OR a monetary phenomenon OR a result of the weak dollar? Do we have fake or real inflation? Put me down for real & stop focusing on the CORE!
Comments (2)
Don't we all wish we could shop at the Ex Food & Energy store. Obviously American's purchasing power is starting to wane with the dollar, but not yet to the point of changing inflation expectations. This is something the fed really focuses on. After the inflation of the 70s and early 80s, the fed cranked rates to near 20% and killed "inflation expectations". That is the tendency for people to believe that prices for everything can only go up. This tendency had driven institutionalized inflation including demands for price index related compensation increases (COLA increases), which really embeds inflation into the way people do business. Once this menace was vanquished, rates were able to drop for a couple decades, helped by cheap imported goods from japan, then Korea, then Taiwan/Thailand/Singapore and now India/China/Vietnam. The pervasive use of mircoprocessors and Moore's law also kicked in their help. However, one can argue that all these trends are gretty well baked into the economy now and maybe even getting played out (certainly tech driven productivity seems to have petered out). Now the big question is when will food and energy inflation and a weak dollar re-fire "inflation expectations. The fed is watching this closely. Interestingly, inflation of food and energy prices (particlularly the latter) can also slow the economy and add to the asset deflation we are seeing from real estate. So there are some trends that are keeping "inflation expectations" at bay.....or we would be having some really bad problems right now.
Posted by Jeff | November 15, 2007 6:03 PM
Economy has fallen “off a cliff,” and that further attempts to intervene are going to result in inflation that will hurt more than help. He also predicts that the recession will rebound, and that things will get better sooner rather than later, which is some good news from Warren Buffet who is a legend in business world. He is one of the few investors that have routinely made money over the last 40 years. His advice is highly sought after, and people pay a lot more than what payday loans will cover to get it. His company, Berkshire Hathaway, has been losing a lot of money over the last few months, an oddity normally, but what is considered par for the course in this current recession.
Posted by Warren Buffet | March 16, 2009 2:51 AM