Economists are saying inflation will not get out of control as long as the expectations for inflation stay down. In the 1970’s, inflation got out of control because businesses made decisions based on the belief that prices would be higher in the coming year. Even Ben Bernanke has gone on the record to clearly state that he does not see any risk for 1970’s-style inflation.
Energy and food have been the primary drivers on inflation fears. This has understandably caused an increased expectation that inflation will be 5.2% next year according to Business Week data. Recently Thomas Hoenig of the Fed warned that “inflation psychology” could become the biggest driver of inflation into the economy.
Maybe with all the chatter about inflation it’s time to take a step back and analyze the economy. Lets for a second forget about $4 gas and $4 box of Cheerios. The economy is barely growing, jobs are being reduced due to cost cutting, and salary increases (adjusted for inflation) have fallen to zero.
Overall, households may expect tighter budgets do to energy and food but, in reality, 70’s-style inflation will not occur. Why? Spending on energy and food substantially cuts spending elsewhere. This has caused the weakest demand in 13 years which, in turn, is causing businesses to cut costs and lower prices rather than raise prices. Unlike the 70’s where wages and prices were pushing up inflation. Inflation is confined to energy and food.
We can really get a picture by looking at core inflation which excludes energy and food. Core inflation is no higher than it was a year ago and is less than it was two years ago. In addition, the past quarter core inflation numbers have slowed even more indicating that weaker demand is already preventing inflation from rising.
Time will tell if inflation stays contained to food and energy. However, it’s worth noting that the unfortunate intrinsic meaning of this gentle outlook outside of food and energy is that it will require weak economic growth to ensure that prices stay down. Given the problems in housing and credit, that is the most likely outcome.
Cliff Pape
Home-Buddies
That’s an exciting write-up Cliff! It’s true that rise in the prices of food and energy have raised inflation fears amongst all with most people neglecting what we call as core inflation. The frequent job cuts is also something that needs to be looked after. Even the Fed has left rates unchanged on the 25th of June thereby stating that economic growth remains weak but it is likely to moderate, though not before later this year. The Fed is not likely to cut down rates; rather it may raise interest rates.
Interesting take. I understand where you are coming from much more than I was expecting at the beginning of your post.
It does seem like the price of everything is going up but food and gas can make it seem that way. I can see what you are saying when mainstream luxuries like the iPhone (not the best example) are dropped in price due to weak demand.
Inflation expectations are certainly there. I remember a couple years ago to expect “hyper inflation” and a sudden change in the US currency! It’s funny but who knows…..
Jessica good point job cuts is a concern that will need to be watched.
Cliff,
I enjoyed your take and both agree and disagree. While I agree that 70s style inflation is not likely to occur, I still do not think we are out of the woods yet on inflationary expectations, which the Fed even expressed concerns over in their policy statement.
This last round of data is relatively skewed due to economic stimulus checks and flood insurance payments. If you look at Real PCE, it doubled on virtually every level from the prior month. Time is the true deliverer of reality, so we can only wait to see how bad it does get, but it is also not worth worrying about or “raising fears” as that almost always ensures your fears will come true.
On the mortgage front, the fundamentals appear to be changing and if they hold we will see lower mortgage rates ahead. Once again, I enjoyed the post and your take on it, good job.
Thank you Robert it is a pleasure to have someone with your vast perspective comment on the economic issues facing our country today!
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marie said,
June 26, 2008 @ 12:24 pmI enjoyed your comments and info on our current economic standing concerning growing inflation. I look forward to reading more news from you about all of this as it continues to progress.
Thanks!
Marie