‘Splitting hairs’ on inflation

When inflation remains low and stable for as long as it has, people get “worried” and start looking for signs that show that cannot be true.

The chart below shows inflation of the core variety (which abstains from volatile elements to better show the inflation trend) for the past quarter century.

Then, the ‘dumb views’ proliferate. A recent one is telling:

Inflation has been a puzzle in the U.S. economy for years, failing to move up much when the unemployment rate tumbled. To resolve the puzzle, it helps to look at the U.S. as two economies: one for goods, another for services.

The goods economy has been transformed by trade and technological innovation over several decades, giving consumers access to inexpensive products made in foreign countries or automated factories. The services economy has been more sheltered from international competition and technological change. You can’t hire cheap Chinese labor to serve you pizza or a robot to teach your ninth-grader English.

Because of those differences, inflation behaves differently in the two economies.

“You can have technological innovations that lower the price of TVs, but our technology for, you know, haircuts doesn’t change as much,” says Michael Feroli, the chief U.S. economist at JPMorgan.

The divergence between goods and services price inflation is especially important now because of the unusual behavior of consumer prices.

And people who should know better utter complete nonsense:

A number of factors could rouse goods prices from their slump, economists say. President Donald Trump threatened last month to impose tariffs on up to $150 billion worth of goods imported from China, the U.S.’s largest trading partner, raising fears of a trade war. Mr. Trump’s decision this month to reinstate sanctions on Iran, a major oil producer, has helped send prices for crude to the highest levels since late 2014. A depreciation in the dollar due to large fiscal deficits or other concerns could make imports more expensive.

“That would be messy,” said Vincent Reinhart, a former Fed official and the chief economist at Standish Mellon Asset Management. “They should actually now be concerned about too much inflation because the thing that is costly to adjust (services inflation)…is already above the goal.”

Inflation is a rise in the overall level of prices. Relative price changes have no bearing on inflation, which is a monetary (not price or unemployment) phenomenon.

The chart below depicts the ‘split’ of overall core inflation between goods (or flexible) prices and services (or sticky) prices over the same 25 years.

Why, pray, should the Fed be concerned about “too much inflation”?

The source of inflation is nominal spending (determined by monetary policy). With subdued but stable nominal spending growth, you ‘reap’ subdued and stable inflation.

Does anyone believe the Fed is set to raise nominal spending growth?


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