Over a week ago, Martin Feldstein warned in the Wall Street Journal about inflation starting to pick up in the United States.
Feldstein warns that this pick-up may be just a springtime blip that could be quickly reversed, but he thinks that this will not be the case and that the inflation that some people have been waiting for has finally started to show its ugly head.
Now, we need to be careful about one thing. The inflation that Feldstein is talking about is the inflation of consumer prices. This is considered a "flow" measure because it deals with the prices of goods and services that will be consumed within a short period of time.
We are talking here about prices that might be related to credit bubbles that are related to asset prices. This kind of inflation has been talked about quite a bit over the past several years, the discussion tending to be about housing prices, stock prices and commodity prices.
The concern has been that the generosity of the Federal Reserve in pumping so much "base" money into the financial system has resulted in money flowing through hedge funds, private equity funds and other wealth management vehicles and into asset markets, leading to inflation in the prices of these assets. These funds have not entered into the spending of households and small businesses and others so as to impact the prices of goods that would be consumed within the short run.
Feldstein believes that this period of modest consumer price increases may be coming to an end, even with the unemployment rate still being as high as it is.
It is not so much that consumer price inflation is not low. It is low. However, consumer price inflation seems to be increasing.
The government's preferred measure of consumer price inflation is the index of personal consumption expenditures that comes out monthly. In April, this measure of inflation rose to 1.6 percent, year-over-year, up from 1.1 percent in March.
What is perhaps more important is the fact that this measure may have bottomed out and has started to head back up. It looks as if the bottom may have been reached around September and October of last year. In the August through November period, the year-over-year rate of increase of prices is about 1.0 percent.
In the December through March period, this measure was up 1.2 percent year-over-year with the closing month being up the 1.6 percent mentioned above.
A series that pretty much parallels this one but at a little higher rate is the Consumer Price Index, the CPI. The rate of increase in this measure also seemed to bottom out in the September through November period at 1.1 percent.
In the five-month period starting with November and ending with April, the index was 1.5 percent above a year ago. But, let it be noted, the year-over-year rate of increase was 2.0 percent in April and moved up to 2.1 percent in May.
Has this movement in prices been picked up in the financial markets?
In terms of the bond market, a measure of inflationary expectations has remained relatively constant since the third quarter of 2013. (I calculate this measure by subtracting the yield on the 10-year Treasury Inflation Protected Securities (TIPS) from the yield on the regular 10-year Treasury security.) In the September and October period, I estimated the inflationary expectations built into the bond market were in the 2.0 percent to 2.2 percent range. Recently, this measure of inflationary expectations has been around 2.2 percent.
Looking at this measure does not seem to indicate that investors are upping their expectations of future inflation ... at least for the present.
However, I think that there is another way to look at this, and that is through the foreign exchange market. Foreign exchange rates are determined by what investors believe central banks will be doing as far as underwriting more inflation or less inflation relative to what other central banks are doing. I believe that current movements in foreign exchange markets can tell us a lot.
Two weeks ago the European Central Bank (ECB) met to determine what it would do as far as its monetary policy was concerned to meet the fear of deflation taking place in the eurozone. The news release of its decision indicated a lowering of interest rates and some tinkering with loan purchases. It was felt that the European Central Bank was acting this way so as to spur on bank lending to stimulate the economy and to lower the value of the Euro against the US dollar to stimulate exports, which would also stimulate the European economy.
Europe got very little bounce from these actions of the ECB. The value of the Euro relative to the US dollar was at $1.3600 at the time the new policy parameters were issued. The Euro dropped modestly below $1.3550 for a time, but came bouncing back from these short-term lows.
At the time of writing this post, the Euro had returned to a price of almost 1.3600.
The eurozone is still concerned with the prospect of deflation, and the actions of the ECB were apparently not that convincing to the investment community relative to the possibility that inflation might be picking up in the United States. Furthermore, there seems to be no sign of when the dis-inflation, now being experienced in the European community, will end.
That is, investors cannot be convinced that the inflation in the United States will not be relatively worse than what the Europeans are now facing in their markets. Thus, even though the ECB is loosening up on monetary policy, investors still believe that it cannot match the inflation that is being created by the Federal Reserve System. The Euro will remain strong relative to the dollar.
The other example has to do with England. The value of the British pound has risen by 13.4 percent since David Cameron became the Prime Minister of England. Furthermore, it seems as if the (relatively) new Governor of the Bank of England has become much more concerned recently with the possible re-inflation of the English economy and has publicly discussed the possibility of raising short-term interest rates. This, of course, has resulted in the value of the pound increasing by even more.
Behind all this is the fact that Cameron, since elected, has conducted an economic policy of austerity, something that he has been severely criticized for by the press, international organizations like the IMF, and Labor politicians. Yet, England seems to be healing a lot better than almost everyone including the eurozone and the United States. Now, the concern in England seems to be shifting toward inflation in housing and other areas of the economy.
The point is that investors see Cameron and the British government as much more prudential when it comes to inflation than they see President Obama and the United States government.
That is, in both cases, that concerning the Euro and that concerning the US dollar, investors seem to believe that the United States is the much more likely area to experience inflation in the future. If this is the case, then I believe that you will see more discussions like that of Martin Feldstein and that you will see more inflationary expectations get built into interest rates.
I believe that this is what you now need to start looking for. Unfortunately, I don't believe that any pickup in consumer price inflation will much improve labor market conditions. The key here is that we have only a 62.8 percent labor participation rate, the lowest in more than 30 years.
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