The most recent data on consumer price behavior has been released, and the inflation hysterics are wrong again.
The rate of change in the Personal Consumption Expenditures Index, the most commonly tracked benchmark by the Federal Reserve Bank, rose 0.9 percent in September, compared to a year earlier, well below the two percent Fed target. Further, a Bloomberg article reports the global inflation rate is 2.8 percent, the second lowest reading since World War II.
As evidence continues to accumulate in opposition of run-away inflation the policy tone is beginning to shift for hard-nosed inflation hawks.
For instance, two weeks ago Richmond Federal Reserve Bank president Jeffrey Lacker, a long-time inflation hysteric, altered his sentiment admitting that the inflation fears have ultimately been unjustified.
But there is little satisfaction, from an economic welfare point of view, in declaring “I told you so” as downward price pressure, i.e. deflation, can ravage economic growth prospects in a way that’s difficult to overcome. Remember Japan’s lost economic decade of the 1990s?
Deflation, a fall in the overall price level, hinders economic growth through a variety of channels.
First, falling prices increase the real value of debt, thereby disproportionately hurting borrowers relative to lenders. Deflation increases the purchasing power of each dollar. As prices drop, each dollar can purchase more goods and services. Thus, borrowers pay back more in terms of what their money can buy than what they originally borrowed, increasing the cost to service debt.
Second, deflation can easily evolve into a downward spiral of prices.
Decreases in the prices for goods and services reduce firm revenue and, thus, profits, leading to lower production. Additionally, firms are encouraged to undercut competitors’ prices to gain market competitiveness.
This, in turn, depresses wages and aggregate demand for goods and services, pushing prices down further. Concurrently, productive capacity idles and firms’ investment spending stagnates. Consumers hold off on spending as they anticipate future rounds of price reductions, further decreasing demand for goods and so on.
The problem of potential deflation is compounded by the current state of short-term interest rates at the zero-lower-bound.
Deflation is effectively an increase in a loan’s interest rate. Even a debtor taking out a zero-interest rate loan will pay back more in real terms (the amount of goods which may be purchased) if prices decrease. But, since short-term rates cannot be reduced below zero to offset the potential for falling prices, deflation will consequently increase real borrowing costs.
Of course, different metrics of price changes will typically generate different results.
The popular Consumer Price Index showed an annual inflation rate for September of 1.2 percent. But, even more intricate and up-to-date measures of price level movements are available and closely watched by economists and policy makers. One such example is the billion price project index generated by Massachusetts Institute of Technology researchers.
The BPPI tracks the prices of billions of e-commerce goods at daily, monthly and annual frequencies. The latest reading from Nov. 10 showed an annual inflation rate of 1.9 percent, closer to the Fed target. What’s more, the producer price index, tracking prices that producers receive for their goods and services at different stages of production process, actually decreased 0.2 percent in September compared to a year earlier.
This begs the question, which of the Federal Reserve’s dual mandates of full employment or price stability should be given priority under current conditions?
The answer is clear. The economy and jobs should be the number one priority of our nation. Our economy is producing three to four percent below its potential output, 11 million people are unemployed and four million citizens willing and able to work have been without a job for over 27 weeks.
Combine this with anemic inflation, and there should be little debate on the direction of policy. Unfortunately, politics seems to be a zero-sum game.
Dr. Nicholas J. Mangee is an assistant professor of economics at Armstrong Atlantic State University and can be reached at Nicholas.mangee@armstrong.edu.