Saturday, June 19, 2021

What Is Normal Inflation?

 Popular Economics Weekly


The financial markets were shocked, yes shocked, when the May Consumer Price Index for retail prices jumped 4.9 percent year-over-year. Just kidding. No one was really surprised because one year ago it wasn’t rising at all (well, just 0.22 percent), and it was predicted to rise substantially with the $4 trillion plus in government aid already being injected into companies and individuals.

It has averaged around two percent since the 1990s, per the above St. Louis Fed graph that dates back to 1950. Every business economist would know this, and expect such fluctuations that rather quickly return to the longer-term average with today’s just-in-time, global supply chains that have tamed prices.

In fact, CPI inflation was rising as high as 5.5 percent annually in July 2008 during the Great Recession, before another jaw-dropping plunge to -0.32 percent in 2009. You get the drift. So who is worrying about these temporary ‘blips’ in inflation?

The financial markets, of course. They love to use other peoples’ (borrowed) money to finance their stock, bond and commodity market transactions, if possible. And interest rates have been at rock bottom over the past year; close to zero for short-term rates, and the 10-year benchmark treasury yield below one percent for much of the time. It is still in a daily trading range of 1.5-1.6 percent, per the below FRED graph.


This is one reason market indexes have been at record highs, and why they gyrate so wildly on almost a daily basis, as traders try to guess what the Fed will do next in its almost daily pronouncements on when they might allow short-term interest rates to rise.

Consumers don’t have to worry so much, because it has been extremely difficult for the Federal Reserve, or anyone else, to keep CPI inflation above two percent, especially during this once in a 100-year coronavirus pandemic. Inflation below that range has invariably meant there is too little aggregate demand—consumers aren’t buying, investors aren’t investing, and banks aren’t lending.

CEPR’s Dean Baker just remarked on what has boosted inflation of late. It’s gasoline prices and insurance rates spiking because of the sudden surge in travel, as consumer bust out of their prolonged at home hibernation.

“Overall, the story this month is overwhelmingly that bounce back inflation was 100 percent predictable, coupled with soaring car prices (both new and used) due to temporary shortages. There’s not much here to get excited about,” he said.

“The overall CPI was up 0.6 percent (monthly), the core rose 0.7 percent. New and used cars were major factors, rising 1.6 percent and 7.3 percent, respectively. The jump in used and new car prices added 0.3 percentage points to the inflation rate for the month.”

And, he continues:

  • · Even though it’s hard to get good help, restaurant prices outpaced food prices by just 0.1 percentage points over the last three months, 1.0 percent to 0.9 percent.
  • · The medical care index fell 0.1 percent in May, up just 0.9 percent over last year. Drug prices were flat, down 1.9 percent over last year.
  • · Rent indexes: rent proper increase just 0.2 percent; owner equivalent rent rose 0.3 percent in May.
  • · Apparel prices jumped 1.2 percent in May, car insurance 0.7 percent, and air fares 7.0 percent. The indexes are respectively 2.2 percent, 0.2 percent, and 6.3 percent below the February 2020 level.

It is also why the housing market is booming. Interest rates are this low because bond traders see very little danger of longer-term inflation, and the Fed promising to hold short-term rates close to zero for at least one more year.

Harlan Green © 2021

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