Inflation? What Inflation?

Today’s announcement of the prelminary estimate of GDP for the fourth quarter of 2011 showed a modest improvement over the anemic growth rates earlier in the year, confirming the general impression that things have stopped getting worse. But we are barely at the long-run trend rate of growth, which means that there is still no recovery, in the sense of actually making up the ground lost relative to the long-run trend line since the Little Depression started.

The other striking result of the GDP report is that NGDP growth actually fell in the fourth quarter to a 3.2% annual rate, implying that inflation as measured by the GDP price deflator was only at a 0.4% annual rate, a sharp decline from the 2.6-2.7% rates of the previous three quarters. The decline reflects a possible tightening of monetary policy after QE2 was allowed to expire (though as long as the Fed is paying 0.25% interest on reserves, it is difficult to assess the stance of monetary policy) as well as the passing of the supply-side disturbances of last winter that fueled a rise in energy and commodity prices. So we now seem to be back at our new trend inflation rate, a rate clearly well under the 2% target that the FOMC has nominally adopted.

Despite the continuing cries about currency debasement and the danger of hyperinflation from all the usual suspects, current rates of inflation remain at historically  low levels.  The first of the two accompanying charts tracks the GDP price deflator since 1983. The deflator is clearly well below the rates that have prevailed since 1983 when the recovery to the 1981-82 recession started under the sainted Ronald Reagan of blessed memory.  The divergence between inflation in the Reagan era and the Obama era is striking.  Inflation under the radical Barack Obama is well below inflation under that quintessential conservative, Ronald Reagan.  Go figure!

The companion chart tracks the Personal Consumption Price index over the same period. The PCE index is similar to the CPI, and shows a similar (but even sharper) decline in the fourth quarter compared to the higher rates earlier in the year, owing to the importance of food and energy prices in the PCE index.  Again the contrast between inflation under Reagan and under Obama is clear.

In his press conference on Wednesday, Bernanke signaled, to the apparent dismay of the Wall Street Journal editorial board, that he will push for a monetary policy that adjusts as needed to keep the inflation rate from falling below 2% and might even tolerate some overshooting while unemployment remains unusually high. That signal apparently caused an immediate increase in inflation expectations as measured by the TIPS spread. The increase in inflation expecations was accompanied by a further decline in real interest rates, now -1% on 5-year TIPS and -0.16% on 10-year TIPS. With real interest rates that low, perhaps we will see a further increase in investment and a further increase in household purchases of consumer durables.  Perhaps some small reason for optimism amid all the reasons to be depressed.

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15 Responses to “Inflation? What Inflation?”


  1. 1 Frank Restly January 27, 2012 at 12:44 pm

    “With real interest rates that low, perhaps we will see a further increase in investment and a further increase in household purchases of consumer durables.”

    You will not see savings rates go much lower, and so I fail to see how household purchases of consumer durables is going to change anything:

    http://research.stlouisfed.org/fred2/graph/fredgraph.pdf?&chart_type=line&graph_id=&category_id=&recession_bars=On&width=630&height=378&bgcolor=%23b3cde7&graph_bgcolor=%23ffffff&txtcolor=%23000000&ts=8&preserve_ratio=true&fo=ve&id=DSPI_PCE&transformation=lin_lin&scale=Left&range=Custom&cosd=1960-01-01&coed=2011-11-01&line_color=%230000ff&link_values=&mark_type=NONE&mw=4&line_style=Solid&lw=1&vintage_date=2012-01-27_2012-01-27&revision_date=2012-01-27_2012-01-27&mma=0&nd=_&ost=&oet=&fml=%28a-b%29%2Fa&fq=Monthly&fam=avg&fgst=lin

    “The divergence between inflation in the Reagan era and the Obama era is striking. Inflation under the radical Barack Obama is well below inflation under that quintessential conservative, Ronald Reagan. Go figure!”

    Real disposable income growth (1980-1984) under the conservative Volcker:

    http://research.stlouisfed.org/fred2/graph/fredgraph.pdf?&chart_type=line&graph_id=&category_id=&recession_bars=On&width=630&height=378&bgcolor=%23b3cde7&graph_bgcolor=%23ffffff&txtcolor=%23000000&ts=8&preserve_ratio=true&fo=ve&id=DSPIC96&transformation=pc1&scale=Left&range=Custom&cosd=1980-01-01&coed=1984-01-01&line_color=%230000ff&link_values=&mark_type=NONE&mw=4&line_style=Solid&lw=1&vintage_date=2012-01-27&revision_date=2012-01-27&mma=0&nd=&ost=&oet=&fml=a&fq=Monthly&fam=avg&fgst=lin

    Real disposable income growth (2008-2011) under the liberal Bernanke:

    http://research.stlouisfed.org/fred2/graph/fredgraph.pdf?&chart_type=line&graph_id=&category_id=&recession_bars=On&width=630&height=378&bgcolor=%23b3cde7&graph_bgcolor=%23ffffff&txtcolor=%23000000&ts=8&preserve_ratio=true&fo=ve&id=DSPIC96&transformation=pc1&scale=Left&range=Custom&cosd=2008-01-01&coed=2011-11-01&line_color=%230000ff&link_values=&mark_type=NONE&mw=4&line_style=Solid&lw=1&vintage_date=2012-01-27&revision_date=2012-01-27&mma=0&nd=&ost=&oet=&fml=a&fq=Monthly&fam=avg&fgst=lin

  2. 2 Benjamin Cole January 28, 2012 at 9:09 am

    Now, this is blogging with a Capital “B”!!!

    Great post!

    Like Japan, our central banks are discovering that zero interest rates alone do not bring inflation, or real growth.

    John Taylor, Allan Meltzer, Milton Friedman and Ben Bernanke all advised Japan to go to aggressive QE to ignite their economy. Since that era, we have progressed in our thinking to the creation of Market Monetarism, a framework in which QE would be more effective.

    Now is the time, Ben Bernanke. Now is the time…put the printing presses on high, lock the door, and take a long vacation until 2013. Moon anybody who criticizes you. This is your hour!

    Re-assess than.

  3. 3 David Pearson January 29, 2012 at 11:46 am

    David,
    “With real interest rates that low, perhaps we will see a further increase in investment…”

    How do negative real rates (across time/countries) correlate with investment spending? With equity valuations (P/E ratios)?

    If I had to guess, it would be that the correlation is inverse.

  4. 4 David Glasner January 30, 2012 at 1:33 pm

    Frank, Households have been cutting back on their spending, trying to pay down their debts. If real interest rates were lower, they would feel less urgency in paying down their debts and would increase their purchases of durables. Thanks for the graphs.

    Benjamin, I thought that you would like this one.

    David, Causality runs in both directions, so the empirical correlation is not likely to show that investment increases with low interest rates. It’s called the identification problem. Nevertheless a reduction in real interest rates would tend to increase investment compared to what it would have otherwise been.

  5. 5 Frank Restly January 30, 2012 at 5:45 pm

    David,

    Several things. First, existing debt owed by consumers tends to be a fixed term agreement (neglecting refinancing). And so lower market interest rates affect new borrowers positively (market opportunity) and existing borrowers negatively (missed market opportunity). Second, consumers are also debt holders and so lower interest rates also reduce available income to pay off existing debt (slower money velocity). Lower real interest rates are even worse because the price of non-durable goods rises sapping the ability of consumers to pay down debt (let alone buy durable goods).

    “If real interest rates were lower, they would feel less urgency in paying down their debts and would increase their purchases of durables. Thanks for the graphs.”

    And I presume you have an economic theory of consumption? Milton Friedman had a theory on it called the permanent income hypothesis. People make spending decisions based on their anticipated future income. Holding real and nominal interest rates at zero reduces that future income.

  6. 6 David Glasner February 1, 2012 at 1:46 pm

    Frank, Do reduced mortgage rates tend to increase the demand to purchase homes?

  7. 7 Frank Restly February 1, 2012 at 3:24 pm

    “Frank, Do reduced mortgage rates tend to increase the demand to purchase homes?”

    Let me answer that by referring to your original postulation:

    “If real interest rates were lower, they would feel less urgency in paying down their debts and would increase their purchases of durables. Thanks for the graphs.”

    Now, as you are probably aware, the measure of inflation that most economists follow is either the GDP Deflator, or the consumer price index (with or without food and energy). What is noticeably absent from those measures is a measure of housing prices. Back in 1983, housing prices were replaced with owner’s imputed rent in the CPI – basically a measure of what a house would rent for.

    You would think that housing prices and owner’s imputed rent would track very closely and you would be wrong.

    And so, when we talk about real interest rates, we have to be careful about exactly which interest rates (government, mortgage, corporate, etc.) and what goods are purchased with that debt.

    Back to your assumption: If real interest rates were lower, they would feel less urgency in paying down their debts and would increase their purchases of durables.

    The only way for “real interest rates” on housing prices to fall much further is for housing prices to rise. The only way housing prices will rise is if more people are buying houses. The only way more people will buy houses is if more people have income to buy the houses. The ways people have more income that are influenced by the federal government are – more jobs (trade balance), more after tax income (tax policy), and more interest income (interest rate policy).

    Of course there are other ways that more houses are bought (population growth, profit returns to shareholders through dividends, charity, etc.), but from a government policy standpoint that is pretty much it. You might throw in poor mortgage underwriting standards and outright fraud but those are not viable long term solutions.

  8. 9 David Glasner February 3, 2012 at 9:18 am

    Frank, I agree that there are major problems with the measurement of inflation because asset prices are excluded from the conventional price indices. Ben Klein and Armen Alchian wrote a paper on this over 30 years ago. Real interest rates are not specific to housing prices. There is one real interest rate and it doesn’t differ for different commodities. Because you put up collateral for a mortgage, there is a lower interest on a mortgage than on unsecured loans, but that is because of the terms of the loan, not because there are different interest rates for different commodities.

  9. 10 Frank Restly February 3, 2012 at 3:53 pm

    “There is one real interest rate and it doesn’t differ for different commodities.” – ???

    Interest RateS

    http://research.stlouisfed.org/fred2/graph/fredgraph.pdf?&chart_type=line&graph_id=&category_id=&recession_bars=On&width=630&height=378&bgcolor=%23b3cde7&graph_bgcolor=%23ffffff&txtcolor=%23000000&ts=8&preserve_ratio=true&fo=ve&id=MORTG,BAA,AAA,DGS30&transformation=lin,lin,lin,lin&scale=Left,Left,Left,Left&range=Custom,Custom,Custom,Custom&cosd=1977-02-15,1977-02-15,1977-02-15,1977-02-15&coed=2011-12-01,2011-12-01,2011-12-01,2012-02-01&line_color=%230000ff,%23ff0000,%23006600,%23ff6600&link_values=,,,&mark_type=NONE,NONE,NONE,NONE&mw=4,4,4,4&line_style=Solid,Solid,Solid,Solid&lw=1,1,1,1&vintage_date=2012-02-03,2012-02-03,2012-02-03,2012-02-03&revision_date=2012-02-03,2012-02-03,2012-02-03,2012-02-03&mma=0,0,0,0&nd=,,,&ost=,,,&oet=,,,&fml=a,a,a,a&fq=Monthly,Monthly,Monthly,Daily&fam=avg,avg,avg,avg&fgst=lin,lin,lin,lin

    And that is just 30 year debt not adjusted for any measure of inflation. As for inflation:

    http://research.stlouisfed.org/fred2/graph/fredgraph.pdf?&chart_type=line&graph_id=&category_id=&recession_bars=On&width=630&height=378&bgcolor=%23b3cde7&graph_bgcolor=%23ffffff&txtcolor=%23000000&ts=8&preserve_ratio=true&fo=ve&id=USAGDPDEFAISMEI,CPIAUCSL,CPILFESL&transformation=pc1,pc1,pc1&scale=Left,Left,Left&range=Custom,Max,Max&cosd=1960-01-01,1947-01-01,1957-01-01&coed=2010-01-01,2011-12-01,2011-12-01&line_color=%230000ff,%23ff0000,%23006600&link_values=,,&mark_type=NONE,NONE,NONE&mw=4,4,4&line_style=Solid,Solid,Solid&lw=1,1,1&vintage_date=2012-02-03,2012-02-03,2012-02-03&revision_date=2012-02-03,2012-02-03,2012-02-03&mma=0,0,0&nd=,,&ost=,,&oet=,,&fml=a,a,a&fq=Annual,Monthly,Monthly&fam=avg,avg,avg&fgst=lin,lin,lin

    This does not include inflation in producer prices (and yes consumer and producer prices can diverge significantly).

  10. 11 David Glasner February 4, 2012 at 8:54 pm

    Frank, The difference in interest rates reflects differences in the characteristic of the borrower and the loan contract. They are independent of the particular items that the borrower is planning to use the proceeds of the loan to purchase.

  11. 12 Frank Restly February 5, 2012 at 6:09 pm

    “Frank, The difference in interest rates reflects differences in the characteristic of the borrower and the loan contract. They are independent of the particular items that the borrower is planning to use the proceeds of the loan to purchase.”

    Umm…. No. The reason is that the lenders don’t make loans with blinders on. There are many factors in determining whether a loan is made and at what interest rate – one of them being credit risk, another being collateral risk.

    Simple question – have you ever gotten a loan of any substance without telling your lender what you intend to buy? Car loans, student loans, and mortgages are the big three, and in each case the interest rate that you pay is in part a reflection of your ability to repay the loan and in part a reflection of what you are buying with the loan.


  1. 1 Inflation? What Inflation? « Economics Info Trackback on January 28, 2012 at 11:00 am
  2. 2 La Carpeta Monetaria - La política monetaria global Trackback on January 29, 2012 at 7:01 pm
  3. 3 How Ronald Reagan (Not to Mention Republicans, Conservatives and the Wall Street Journal Editorial Board) Learned to Stop Worrying and Love Moderate Inflation « Uneasy Money Trackback on January 29, 2012 at 7:55 pm

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About Me

David Glasner
Washington, DC

I am an economist at the Federal Trade Commission. Nothing that you read on this blog necessarily reflects the views of the FTC or the individual commissioners. Although I work at the FTC as an antitrust economist, most of my research and writing has been on monetary economics and policy and the history of monetary theory. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey's unduly neglected contributions to the attention of a wider audience.

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