Friday, August 14, 2009

Inflation: A Non-Issue For Now

From the BLS:

The Consumer Price Index for All Urban Consumers (CPI-U) decreased 0.2 percent in July before seasonal adjustment, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. Over the last 12 months the index has fallen 2.1 percent, as a 28.1 percent decline in the energy index since its July 2008 peak has more than offset increases of 0.9 percent in the food index and 1.5 percent in the index for all items less food and energy.

On a seasonally adjusted basis, the CPI-U was unchanged in July following a 0.7 percent increase in June. Small declines in the food and energy indexes offset a small increase in the index for all items less food and energy. The food index declined 0.3 percent in July with all six major grocery store food groups posting declines. The energy index, which rose 7.4 percent in June, fell 0.4 percent in July. Decreases in the indexes for gasoline, fuel oil, and electricity more than offset an increase in the index for natural gas.

Here is the month to month increase/decrease chart of CPI:

Look back at the month to month chart and notice it goes back through 2007-2008 when we had a massive commodity spike. The peak level for that time was right around 5%. This is not a great level, but it is not fatal either. In addition, had the economy not been approaching/in a recession during this time the Fed had the weapon of interest rates to start dealing with the problem.

Now, let's look at two points in the current situation from the perspective of demand pull and cost push inflation. Demand pull inflation occurs when the number of buyers of a good increase relative to the quantity supplied. Or in less "eco-geek" speak there are more buyers than sellers. In that case the price of a good increases. However, consider where we are in the unemployment picture right now -- 9.4%. Incomes are dropping. Retail sales have bottomed and are moving sideways. In short, there is no information out there that indicates we are approaching a situation where people are going to start a large amount of buying. That pretty much eliminates demand pull inflation.

Cost push inflation occurs when commodity prices/input prices increase to the point where industry has to start increasing the prices it charges for goods. However, there is a tremendous amount of excess capacity in the system right now. Capacity utilization is at/near a 40 year low. That means that an input price increase can be dealth with through an increase in capacity. Also note that one of the biggest input costs -- labor prices -- is in no position to ask for an increase in wages. In short, cost push inflation is not an issue either.

Then there is the possibity of an increase in monetary supply. However, that makes several assumptions which aren't valid. First, it assumes the Fed will not mop up excess liquidity in a timely fashion. I find that argument highly unlikely. So far Bernake has done a good job of dealing with this situation. Secondly, consumer loan demand is droppping and loan terms are becoming stricter. This lowers the possibility of an increase in loans which would expand the monetary base. Third, monetary velocity is low right now and given weak consumer demand it is difficult to see where it would increase.

Bottom line -- I simply don't see inflation being an issue for the foreseeable future.