Tuesday, April 17, 2007

About U.K. & U.S. Inflation Reports

Today numbers for consumer price inflation for both the U.K. and the U.S. was released.

The U.K. inflation numbers were really bad. According to the EU-harmonized index, inflation rose to 3.1%-the highest ever since that index was introduced in 1997. According to the traditional (and wider) British consumer price index, the Retail Price Index, inflation rose as high as 4.8%. This forced Bank of England governor Mervyn King to write to chancellor Gordon Brown and explain why it has failed to keep inflation at 2%. According to the BBC News account it blamed the rise on rising oil prices. Which is actually pure BS. Because while oil prices did rise between February and March, they actually fell between March 2006 and March 2007, particularly in pound terms.

Anyway though, this makes a May interest rate increase by the Bank of England a near certainty, which is why the pound rose through the psychologically important $2/£ barrier for the first time since 1992.

By contrast, U.S. inflation numbers were unexpectadly low. While a 0.6% monthly increase isn't low in absolute terms, I had expected a higher number given the surge in both energy and food prices. But while energy prices in the CPI did indeed rise sharply, food prices rose a mere 0.3% and the so-called core index rose just 0.1%.

What is particularly puzzling is the weak food price increases. According to the PPI, food prices at the wholesale level rose 5.7% in the latest 4 months. Yet according to the CPI, food prices at the retail level rose just 1.8% in the latest 4 months. Even if you exclude restaurants, the increase of prices in food stores was just 2.3%. This seemingly implies that retailers have significantly reduced their gross margins. Something which is hardly sustainable. That in turn implies that retail food prices should start increasing faster in coming months, as food stores realize that the increase in input prices isn't temporary.

8 Comments:

Anonymous Anonymous said...

Is it a 1970-1980 inflation and gold bullmarket situation, revisited?

Göran, Sweden

8:17 AM  
Anonymous DH said...

Accoring to BBC inflation was due to an increas in oil prices. If I understand you correctley this were not the case, because oil prices acctually had fallen in mars. Doesn't this miss the fact that an increase/decrease in the price of a particular goods has nothing to do with inflation? If oil prices rise, consumers will spend less on other products, given that the amount of money hasn't changed. On net this will not result in any different " price level" only a possible change in supply and demand.

11:46 AM  
Anonymous Adi the Austrian said...

Yes, of course consumers substitute bread for starvation when they cant buy bread with their income!

Seriously, it's cost of living type of indices of which we are talking about.

Russian/Soviet mathematician Konus has proven following facts. Also Norwegian econometrician Ragnar Frisch had article in Econometrica about following;

If you use Laspeyres type of price indices to measure inflation then there is no substitution effect included.

Paasche type of price index measure s change in the price level after substitution effect has happened. This is because it uses quantities of goods presently purchased.

And Fishers Ideal Index is geometric average of the previous two indices. This corrects problems somewhat.

If one is to measure inflation by the method of Fishers index he will get lower amount.

3:37 PM  
Blogger stefankarlsson said...

Goran: basically yes, although it is unlikely that inflation will reach double digit levels.

dh: BBC News refered to the monthly change, I refered to the annual change. Oil prices were up compared to February, but down compared to Mmarch 2006.

And your reasoning about the effect of oil price changes is partially valid. Higher oil prices should have a slightly negative effect on other prices. But it is unlikely to have such a big effect that there is no effect on overall inflation. Higher oil prices caused by nonmonetary factors represent a decrease in the total supply of goods & services, and a decrease in supply of goods & services should have a price increasing effect just as a money supply increase.

3:38 PM  
Anonymous DH said...

Doesn't your last reply argue for some sort of cost push inflation. Where raising oil prices, imply a more expensive production, which inturn results in higher prices on consumer goods etc... If the MS is constant, by definition, higher prices on oil can't alone bring about inflation. I have a hard time understanding how higher oil prices could bring about a decrease in the total supply of goods and services. In the line of reasoning of disproving cost push inflation, the total supply of goods and services does not necessarely decrease with more expensive oil. Consumer spending on other--not oil related
--goods should increase, driving upp the supply, which on net results in another composition of prefered goods and services, but not any change in the "Price level"

"The contention that a change of the price of oil affects the CPI encourages investors to believe that central banks have nothing to do with inflation. According to the mainstream, inflation is something caused by price movements
of particular (or major categories of) goods and services; and these movements, in turn, are consequences of unpredictable world events or other (and often inexplicable) changes of demand and supply. Given a proper (classical and Austrian) conception of inflation, however, it is obvious that this contention confuses cause and effect. A rising oil price does not cause the CPI to rise, but the central bank’s inflation can (and eventually will) cause the price of oil (and the CPI more generally) to rise. It is simply a myth that the CPI is somehow led around by the nose by major sectors such as energy, food, etc., and that inflation has nothing to do with the money supply – or with central banks."--Chris Leithner

Also se Hayek in The pure theory of Capital

"“It is self-contradictory to discuss a process [inflation] which could not take place without money and at the same time to assume that money is absent or has no effect.”"

9:50 AM  
Blogger stefankarlsson said...

"Cost push" inflation in the sense of higher prices due to decreased supply is indeed real. I don't believe anyone, and certainly not my good friend Chris, would deny that. What I believe he was arguing against was rather the lie from central banks that money supply is irrelevant for price inflation. He wasn't saying that the supply of goods & services is irrelevant. Both are of course relevant. Indeed, it is the fact that the supply of goods & services usually increase that is the cause of the fact that price inflation is usually lower than monetary inflation.

As for the following paragragh you wrote:
"Consumer spending on other--not oil related
--goods should increase, driving upp the supply, which on net results in another composition of prefered goods and services, but not any change in the "Price level"

I don't see why higher oil prices should increase spending on other goods. In fact, the effect is likely the opposite, and that was also what you wrote in your first reply.

If say a war broke out between the U.S. and Iran and this led to the halting of oil shipments from the Persian gulf, this would of course mean that the supply of oil would fall and the price of oil rise sharply . I don't see why this should lead to a higher supply of other goods and so counteract the price increasing effect of lower supply of oil.

10:24 AM  
Anonymous DH said...

Thank you for your clarification!

Lets say the war brings about a multiple increase in the price of oil. Also assume the demand for money is constant. This would put strong preassure on oil dependent industries, who are facing larger production costs and can only deliver their product at a higher price. Depending on the elasticity of the demand for such product isn't it sensible that e g due to large operative cost for petrol engins, other, cheaper alternatives would experiance a higer demand?

In my paragraph I implicitly supposed that the demand for oil didn't change...

When you say that Cost push inflation is indead real because of a supply shock is a real deal, doesn't that somewhat obscure yours as well as Chris ability to argue againt such ludacris as Money supply manipulation.

Price inflation out of context, wtih regard to changes in the money supply and monetary inflation, isn't anything more than a price change.

If after the war there existed only oil and bananas. If some monkey ate half of the bananas, a banana in terms of oil should cost about dubble as much. Do you describe this situation as inflationary.

I may miss your point...

Oterwise, credit for a very good and intersting blog!

11:29 AM  
Blogger stefankarlsson said...

"Lets say the war brings about a multiple increase in the price of oil. Also assume the demand for money is constant. This would put strong preassure on oil dependent industries, who are facing larger production costs and can only deliver their product at a higher price. Depending on the elasticity of the demand for such product isn't it sensible that e g due to large operative cost for petrol engins, other, cheaper alternatives would experiance a higer demand?"

Indeed it would. But remember, higher demand causes prices to rise, not fall. We have in fact a great example of a oil substitute product that have gained in popularity, partially because of rising oil prices, partially because of government subsidies: ethanol.

Increased demand for ethanol has in turn caused the price of the product it is made of, corn, to soar.

"When you say that Cost push inflation is indead real because of a supply shock is a real deal, doesn't that somewhat obscure yours as well as Chris ability to argue againt such ludacris as Money supply manipulation."

I really don't see why. The case against money supply manipulation certainly doesn't rest on the absurd assumption that money supply changes are the only factor influencing prices.

"Price inflation out of context, wtih regard to changes in the money supply and monetary inflation, isn't anything more than a price change.

If after the war there existed only oil and bananas. If some monkey ate half of the bananas, a banana in terms of oil should cost about dubble as much. Do you describe this situation as inflationary."

Well, yes, in the sense of price inflationary.

3:03 PM  

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