Wednesday, October 21, 2009

Inflation Isn't An Issue

The idea that inflation is going to increase has been bouncing around the financial press and blogsphere for a bit. The primary reason people are making this argument is the size of the fiscal stimulus. Because the Fed is injecting a lot of money into the economy that will lead to a huge debasement of the dollar. However, the numbers don't jibe with that argument.

First, consider these charts:

CPI has been increasing since the end of last year but not at a higher rate of increase than before. Remember "rise over run" from algebra class? That measures the steepness of the line. Again -- the CPI line isn't scary.

Neither is PPI. Both indexes are showing a general upward sloping trend that is not threatening.

Let's take a look at the monetary base:

Above is a chart of the percentage change in M2 year over year. Notice we peaked at a higher absolute rate after both the second 1980s recession and the 2001 recession.

And then there is the issue that we won't see an increase in demand pull or cost push inflation. First, here is a definition of demand pull inflation:

A term used in Keynesian economics to describe the scenario that occurs when price levels rise because of an imbalance in the aggregate supply and demand. When the aggregate demand in an economy strongly outweighs the aggregate supply, prices increase. Economists will often say that demand-pull inflation is a result of too many dollars chasing too few goods.

When unemployment is over 9%, does anybody seriously think demand pull inflation is an issue? Anyone?

And then there is cost push inflation:

A phenomenon in which the general price levels rise (inflation) due to increases in the cost of wages and raw materials.

Wage pressures aren't going to be an issue as mentioned above. And remember two years ago when we saw huge commodities' price spikes? Here is a year over year PPI chart that goes back 40+ years:

This chart says two things:

1.) We've seen higher price spikes -- and

2.) They don't last that long. There are two inter-related reasons for that. First, price spikes of that size are by definition demand killers. When something gets that expensive, people don't buy as much of it. Secondly, notice that price spikes typically happen before a recession. Notice that high year over year changes preceded both 1970s recessions and the last two recessions. This is more of a corollary to the first rule -- that high prices are by definition demand killers. But the point is clear: cost push inflation isn't a current issue and if it gets to be an issue the possibility of another recession are also increasing.

And commodity prices are nowhere near demand killing levels yet.

Simply put, the inflation argument is moot.