Issue: 93
Sent: 18-12-2007 14:00:03
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No More Falling Inflation - John Robertson
As we conclude the year, inflation seems to be looming as a larger threat to global economic well being.
On Friday, the US government released inflation statistics for November. They showed a 0.8% jump in consumer prices for the month and a 4.3% rise from a year earlier.
This makes reported inflation as high as it has been since the middle months of 1991.
In the immediate aftermath of the announcement, US commentators began talking about stagflation. While this might be the sort of exaggeration journalists enjoy, it contains an element of truth. We might well be moving through a transition in the inflation performance of the world’s largest economy.
The so-called underlying rate of inflation is not as high as this. If we exclude the effects of food and petrol prices, the increase for the month was a more subdued 2.3%. This is less worrisome than the unadjusted information.
Nonetheless, this is still toward the upper end of the range US policymakers are comfortable allowing to continue. Using this underlying rate is all very well when items like oil and food are displaying aberrant behaviour. If you can count on them retracing to more normal levels after a short-lived jump, it is entirely sensible to discount their impact in any one month.
But that is not what is happening. Oil prices appear set to remain high and volatile. They might fall back to sub-$50 per barrel. However, they could also go to $120 per barrel or above.
Food prices, meanwhile, like many other commodity groups are on the rise. One influence in the US is the amount of corn that is now being committed to ethanol production.
Treating these factors as irrelevant to macroeconomic policy making might no longer be a sensible assumption.
The chart at http://www.thebigpicture.com.au/atc/us_inflation.htm highlights six phases in the history of US inflation over the past five decades.
Phase one was the period of low inflation in the early 1960s.
Phase two was the Vietnam War and US deficit spending related acceleration in rates of price increase.
Phase three was the stagflation period of slow growth, strong inflationary expectations and global dislocation which occurred for the decade after the US quit Vietnam.
Phase four came after Paul Volker’s tight monetary policies brought inflation to heel in the 1980s.
Phase five was the period from the early 1990s to 2004 when global competitive forces, reductions in trade barriers and the introduction of new technologies forced the prices of traded goods lower and helped to support an upsurge in productivity.
The sixth phase is the current transition from falling inflation. While the forces creating these outcomes are by no means unravelling, they were always going to lose their impact at some stage. Whether that is happening now or whether there is still some way to go might be open to some conjecture. Whatever the precise timing, it is highly likely that we are closer to the end of these forces exerting their influence than we are near the beginning.
If we are making such a transition, monetary policy will never be as easy as it has been again. The trade off between growth and inflation which has been largely absent from policy making for two decades will start to reassert itself.
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