Tag Archives: inflation

A Key Index of Inflation in the US Has Come Down

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There are signs that inflation is coming down.  While still early and preliminary, recent monthly figures for the inflation indices that many economists (and Federal Reserve Board members) focus on, suggest a break from the inflation rates seen earlier in 2022.

On January 27, the Bureau of Economic Analysis (BEA) released its most recent monthly report on Personal Income and Outlays, with estimates for December 2022.  The figures are part of the National Income and Product Accounts (or NIPA, often referred to as the GDP accounts) that the BEA is responsible for.  The accounts include estimates for Personal Consumption Expenditures (PCE), and to put those into real terms the BEA also estimates the price indices that apply to those expenditures.  Items are weighted as they are for the Personal Consumption component of the GDP accounts.

The prices shown are all seasonally adjusted and at annual rates.  There is a great deal of volatility in the month-to-month figures, so it is best to focus on the trends over several months.  Many commentators focus on the year-on-year figures (a 12-month moving average), and these are shown as the red line in the charts.  But a 12-month period is long, and one does not know if changes observed are due to recent events or to events of close to a year ago.  For this reason, I prefer the shorter 3-month moving average figures (in blue).  As one can see, major changes in the 3-month figures will often give a good indication of where the 12-month figures will soon go.

The first chart at the top of this post shows values for the overall rate of inflation (where all personal consumption expenditures are included), while the second chart shows the values for core inflation (where food and energy items are excluded).  Core inflation is a better indicator of inflationary pressures, as food and energy costs are largely commodity items with prices that go down as well as up.  Their fluctuations are often wide.  Other prices are typically more “sticky”, and hence the core inflation index that excludes the volatile food and energy components serves as a better indicator of the trends.

Three-month core inflation rates have come down from around an average of about 5% (remember that all figures are at annual rates) during most of 2021 and 2022, to 3.6% in the 3-month period ending in November and then 2.9% in the period ending in December.  The overall PCE inflation rate fell earlier, from a higher level, and by more.  It was generally between 7 and 7 1/2% from late 2021 to June 2022 (and hit 8.6% in the 3-month period ending in March), but then fell to a range of between 2 and 4% since September.  In the three months ending in December, it was just 2.1%.  Interestingly, the 6-month change for the second half of 2022 was also 2.1% (at an annual rate).

Energy prices are a major part of this.  While the core inflation rate removes energy items from the basket of items included in the inflation index (along with food), those energy items will be those directly purchased by households.  That is, the core inflation index removes items such as gasoline purchased for your car or natural gas to heat your home.  But energy prices will also affect other prices indirectly – for example from the cost of fueling the trucks that bring items to the markets.  Based on the index of energy prices used in the computation of the overall PCE inflation index, energy prices rose sharply in March 2022, following Russia’s invasion of Ukraine in late February.  But the energy price index reached a peak in June 2022 and has since fallen almost to where it was in February 2022, just prior to the invasion.  Whether it will fall further is not known, but a further major fall from where it was in December is probably not likely anytime soon.  In this case, the inflation indices may not fall much further in the coming months, and may well bounce back up a percentage point or so.  But the trend is likely still downwards.

As noted before, these figures are still early.  One should expect fluctuations going forward, as there have been in the past.  And inflation in the next few months may well be higher than in the last few.  But the figures do suggest that inflation has come down, and has come down despite still very tight labor markets.  The unemployment rate was 3.5% in December – matching the lowest it has been since 1969, more than a half-century ago.  And the labor market has been tight for some time.  Unemployment was in the range of just 3.5 to 3.7% from March onwards, which is about the range of month-to-month statistical uncertainty in the estimates.

Despite these figures on inflation, there have been at least some prominent economists arguing inflation will remain high for an extended period.  Ken Rogoff – a professor at Harvard and a former chief economist for the IMF – authored a major article for the recent November/December issue of Foreign Affairs titled “The Age of Inflation”.  In it he wrote:

the world may very well be entering an extended period in which elevated and volatile inflation is likely to be persistent, not in the double digits but significantly above two percent.

Nouriel Roubini (often nicknamed “Dr. Doom” for his frequent pessimism, but who correctly forecast the 2008 financial collapse) has argued similarly, saying that high inflation will be with us for a very long time.

There are, of course, also economists arguing the other side – arguing that inflation has been and will be coming down.  The most well-known is perhaps Paul Krugman.  Another would be Jason Furman, a professor at Harvard and previously a chair of the Council of Economic Advisors during Obama’s presidency.  While they had argued earlier, in 2021, that inflation would not rise as far as it did and for as long as it did following the massive Covid spending packages of both Trump and Biden (totaling $5.7 trillion in federal government spending, or a huge 12.8% of GDP of 2020 and 2021 together), they now recognize and acknowledge that mistake.  But it is important also not to err in the opposite direction.

We will see what develops.  But based on what inflation has been in recent months, it very much looks like there has been a break from earlier levels and that the trend is downwards.

Obama and Prices: The Markets Expect Inflation to Remain Low

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US Treasury Bond Yields, TIPS, and Expected Inflation, Jan 2, 2003, to Aug 8, 2013

Conservative critics of Obama argue his policies will inevitably lead to high inflation.  A previous blog post on this site showed that in fact inflation during the four years of Obama’s first term had been the lowest over any presidential four year term going back a half century.  Low inflation during Obama’s first term cannot be denied.

The conservative critics respond that while inflation may have been low so far, it is inevitable that inflation will soon rise.  The blog post cited above provides links to several examples of what they have been saying.  But this assertion can be examined as well.  In particular, the financial markets (which the conservative critics generally take as reflecting a sound view on such matters, as the investment returns of such investors will depend on getting this right) can be used to see what at least the markets believe inflation will be going forward.

Since 1997 the US Treasury has been issuing bonds of varying maturities whose principal is indexed to the US CPI price index.  These bonds, known as TIPS (for Treasury Inflation-Protected Securities), provide a return which will be the same in real terms regardless of what inflation turns out to be.  The yields on such bonds can be compared to the yields on regular US Treasury bonds of similar maturity.  Such regular US Treasury bonds will pay interest and at the end return the principal in certain dollar amounts, with a value in real terms which will vary depending on what inflation turned out to be.

Inflation is normally positive, so the regular bonds will pay rates which are higher than the rates on TIPS bonds.  But whether the higher rates are worthwhile will depend on how high inflation turns out to be.  To illustrate with some simple numbers, suppose the rate on a 10-year regular US Treasury bond is 3% while the rate on a 10-year TIPS is 1%.  If inflation turns out to be 2%, the bonds will be equally valuable.  But if inflation turns out to be 3%, it would have been better to have invested in the TIPS.  The TIPS will still pay out a 1% real return, while the regular US Treasury will yield a real return of only 0% (a 3% nominal return, but with 3% inflation the real yield will be zero).  Alternatively, suppose inflation turns out to be 1%.  The real return on the regular US Treasury will be 2% (equal to 3% minus 1%), while the TIPS will still yield the contracted 1% real return.  In one believes inflation will be just 1% over this period until maturity, it would have been better to have invested in the regular bonds.

The investors will therefore need to determine what they expect inflation to be.  They will bid up the price of one of the bonds (and bid down the price of the other) if they believe inflation over the time to maturity of the bond, will be higher or lower than the current gap in the yields between the two.  Where the prices of the two bonds settle, and therefore what the gap in yields is between the two, therefore reflects what the financial markets as a whole believe will be the rate of CPI inflation over the period until the bonds mature.  Since real money is riding on this, the investors will take it seriously.

The graph above shows the yields on regular 10-year US Treasury bonds (in blue) and on 10-year TIPS (in green), for the period from January 2, 2003, to August 8, 2013.  The data comes from the official US Treasury web site (where the data presented there goes back to January 2, 2003).  The implied 10-year expected rate of inflation (in red) is then calculated based on the difference between the two yields.

As can be seen in the graph, the yields on the regular 10-year US Treasury bond varied a fair amount over the period, from generally between 4 and 5% during the Bush presidency, falling over time to below 2% for much of 2012, and then rising to about 2 1/2% recently.  The 10-year TIPS yield similarly varied from around 2% during the Bush years, to negative levels for 2012 and the first half of 2013, and rising to a still low but positive 1/2% recently (and most recently just 1/3%).

Despite such fluctuations in the yields of the regular 10-year bond and the 10-year TIPS, the implied expected inflation rate (the difference between the two yields) has been relatively constant, at about 2 1/2% during the Bush years and a similar but slightly lower rate (on average) during the Obama presidency.  The one exceptional period, which should be excluded, would be during the period of economic and financial collapse in the final months of the Bush presidency, after Lehman Brothers went bankrupt and the financial markets were in chaos.  The TIPS yields went up while the regular US Treasury bond yields fell sharply, leading to an implied expectation of inflation of close to zero.  But the figures under such chaotic conditions should not be taken as meaningful.  The chaotic markets then stabilized within a short period of Obama taking office in January 2009, with the rates then returning to more normal levels.

The financial markets, which the conservative critics of Obama normally place a good deal of faith in, therefore do not show any indication that they expect inflation over the next decade to rise.  Rather, they expect inflation of around 2% a year to continue, which is consistent also with the rate of inflation the Fed targets.

Finally, the figures on the bond yields in the graph above also show that the US government has been able to borrow, and continues to be able to borrow, at incredibly low rates, whether in real or nominal terms.   The TIPS yield (the borrowing rate in real terms) was indeed negative in for most of 2012 and the first half of 2013, and is still only 1/2% or less.  Even were it not for the still high unemployment in the country, this is the period when the government should be undertaking investments in both new infrastructure and other assets, and in maintenance of existing assets.  Such investments are worthwhile even if they generate returns of only 1/2% in real terms.  Yet such investments, particularly in maintenance, will generate returns that are orders of magnitude greater than that.

It has been incredibly stupid that the Republican insistence on cutting government spending has blocked us from proceeding with such investments at a time when the borrowing costs to fund them have been so low.

Inflation in Obama’s First Term: The Lowest in a Half Century

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Inflation During Presidential Terms, 1953-2012

One of the most persistent criticisms of Obama and the economic policies followed during his term as president is that they would inevitably lead to high inflation, or indeed hyperinflation according to some.  The argument was that high deficits, driven by high government spending (even though government spending has in fact been coming down, see my previous blog postings here and here), plus the aggressive actions taken by the Fed to help the economy recover from the 2008 collapse, were boosting government debt and the money supply, and this would inevitably lead to soaring inflation.

The arguments have been made not only by conservative politicians and political pundits (see here and here for examples), but also by conservative economists such as John Taylor and Michael Boskin, both full professors at Stanford, who served in high positions in the administrations of Bush, Jr. and Bush, Sr. (respectively), and who also both served as senior advisors to Mitt Romney during his recent presidential campaign.  For examples of some of their non-academic writings on the issue (some co-authored with Congressman Paul Ryan), see here, here, here, and here.  John Taylor has indeed like to joke that the US is heading down the hyperinflationary path of Zimbabwe, and carries around a hundred trillion Zimbabwe dollar note in his wallet (as does Paul Ryan) to show people what may soon happen to the US.  And the forecasts that Obama’s policies will lead to soaring inflation continue.

The forecasts were that soaring inflation would soon be upon us.  But nothing could be further from the truth.  We now have data for the full four years of Obama’s first term, and can compare inflation during this period to that of other presidents.  The graph above shows that average inflation over the four years of Obama’s presidency was the lowest of any presidential term going back a half century to the 1961-64 term of Kennedy/Johnson.  It was substantially lower than inflation during Bush’s two terms, was also somewhat below inflation during Clinton’s two terms (when inflation was less than during Bush), and so on back to Kennedy/Johnson.

The inflation measure graphed above is the GDP price deflator.  This is the most broad-based measure of inflation for the economy as all goods or services produced or used in the economy are covered, weighted by the value of what was used.  One could alternatively have used the price deflator from the GDP accounts for just the personal consumption component of GDP, but the results would have been the same:  inflation by this measure was less under Obama than under any presidency going back to Kennedy/Johnson.  And similarly, one could also have used the consumer price index, the common measure of inflation of goods and services used by households, and again have found the same results.

Inflation during Obama’s first term averaged 1.5% a year (as measured by the price deflator for GDP, and also 1.5% a year as measured by the deflator for the personal consumption component of GDP).  Will it stay so low?  Hopefully not.  The Fed indeed now targets inflation to be about 2% a year, so average inflation during Obama’s first term has been below that target (although close to it in 2011 and 2012:  see the graph above).  With the economy still weak, some analysts have indeed argued that moderately higher inflation of perhaps 4 or 5% a year would help the economy to recover more quickly.  Prominent proponents of such a higher target include Professor Paul Krugman (see here and here) and Olivier Blanchard, the chief economist of the IMF (see here).

Inflation can thus be expected to rise above what it has been, and indeed there would be benefits were it to rise to a still modest level such as 4 or 5% for a period.  But inflation over Obama’s presidency up to now has been exceptionally low, and the forecasts by the conservative politicians, pundits, and even some economists that Obama’s policies would quickly lead to soaring inflation could not have been more wrong.