The Trouble with Inflation
Fed Chairman Janet Yellen recently offered up arguments in favor of running a “high-pressure economy” to repair the damage done by the Great Recession. Yet, the economy may already be running hotter than she thinks. With ECRI’s U.S. Future Inflation Gauge (USFIG) climbing to a 99-month high, cyclical inflation pressures have strengthened considerably (not shown). Meanwhile, year-over-year (yoy) CPI inflation has climbed to a 23-month high of 1.5% (not shown). A decomposition of this CPI data is instructive.
Following the upswing in the USFIG, yoy core CPI services inflation has turned up, and is hovering around an eight-year high of 3.2% (black line), boosted by sustained uptrends in shelter and health care inflation. Holding headline inflation down are yoy core CPI goods growth (gray line) and CPI food and energy growth (orange line), both of which are still in negative territory.
However, CPI food and energy growth has already risen to a 22-month high, following the stabilization in energy prices. In contrast, weighed down by falling prices – especially for vehicles and apparel – yoy growth in the CPI for core goods is languishing near a nine-year low, having stayed in negative territory almost continuously for some 3½ years. The last time this metric had remained below zero for nearly as long was in the 2001-04 period, under assault from the “globalization tsunami.” This behavior is consistent with the downswing in global export prices that began in the summer of 2011 and started to intensify in the summer of 2014, with yoy export price growth staying deep in deflationary territory (not shown).
The divergence could not be starker between sustained structural lowflation and deflation in tradable goods, and the cyclical upturns in inflation in non-tradable services and food and energy prices. But they do not offset one another, any more than having one foot in ice water and the other in scalding water feels comfortable, on average.
Rather, the inflationary upswing in the prices of core services like health care and shelter, as well as food and energy – which are mostly non-discretionary expenditures – effectively squeeze consumer budgets for discretionary expenditures, many of which are for core goods like vehicles and apparel, where inflation is further suppressed as a result. Contrary to Ms. Yellen’s expectations, it is doubtful that the consequence of a high-pressure economy would be to “raise the productive capacity of the economy by encouraging additional capital spending” – especially in manufacturing, where the structural damage to the labor market has been so devastating.