The glories of a little bit of inflation
The consumer price index jumped 0.7% (seasonally adjusted) in June, the biggest monthly rise since last summer. Most of the gain came from rising gasoline prices: the CPI excluding food energy (what they call core inflation) was up only 0.2%. And prices overall are still down 1.4% from a year ago. This ain't no inflationary spiral. But with yesterday's report that producer prices were up 1.8% for the month—well above most forecasters' expectations—the CPI news makes it apparent that it's no deflationary spiral either.
It was the belief of the brilliant (if somewhat nutty and sometimes laughably wrong) economist Irving Fisher that what made the Great Depression so great (meaning terrible) was deflation. Falling prices and wages turned a downturn into a total meltdown because businesses and consumers couldn't pay back debts incurred back when prices were higher. Fisher's Debt-Deflation Theory of Great Depressions was partly resurrected by Milton Friedman in the 1960s, and it has been at the heart of the Ben Bernanke's crisis-fighting approach over the past couple of years. The basic idea is that if you fend off deflation, you fend off complete economic disaster.
All indications are that deflation has been successfully fended off—so far, at least. It was in July of 1930, nine months after the stock market crash of October 1929, that the Great Depression's Great Deflation began, with the annualized inflation rate plummeting to -4.05% from -1.75% the month before. (The rate eventually got to -10.74%, in October 1932.)
Of course, there's a very real risk that today's deflation-fighting obsession will eventually lead to high inflation. But it seems a bit crazy—unless you're trying to figure out what price you're willing to pay for 30-year Treasury bonds—to obsess over that just now.
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1
An excellent analysis and post.
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Yes, it is an excellent analysis. The thing to really understand is that our entire economic fabric throughout the world is based upon the idea that a little inflation is good, and indeed necessary for a healthy economy.
Paul Volker has already proved that the government, given a determined enough Fed chief, can break the back of inflation. What we do not know is what does it take to break the back of deflation beyond a WWII and a public works project that spans the Manhattan Project, the Tennessess Valley Authority and the Interstate highway system. Those, are as someone once said, and I believe as Japan would attest, the unknown unknowns.
The reason it is so dangerous is because it can bring about systemic failure of the banking system. As we give up earning power because sales and pricing power go down, the system becomes self-sustaining. Further, it really creates problems for banks in that it makes the likelihood of seeing repayment of loans less likely as well. I'm full on scared of more deflation...and I hope that everybody is praying to God at night for a good bit of inflationary pressure.
But to be honest, I think it is too early to say. How can you have inflation with so many people out of work and a sustained 10% unemployment rate and housing vacancies which are far larger than at anytime since maybe the Great Depression (at least projection-wise if all of the foreclosures go through). A rise in prices only occurs where there is a shortage and relative scarcity of goods, right? Here we have way too many houses, too many cars, and a ton of workers all looking for something to do. Where is the inflationary pressure going to come from? China? Europe?
I would say that seeing inflation in this environment is like seeing green shoots right before a Texas summer. It won't last.
- foxjust About to walk to LA Public Library for this http://bit.ly/7LgRu6 Am told only a nobody walks in LA - 5 days ago
- foxjust just took first ride on LA metro. Totally disorienting not to have car to park here - 5 days ago
- foxjust Thanks to Bama fans for reminding us we needed to buy TP! (Turns out we're fine on detergent). Oh, and nice game #ironbowl - 1 week ago
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