Tuesday, November 24, 2009

Price Inflation Recovering Fast

In July, the inflation rate reached a low of -2.1%. Since then, this number has increased to -0.2% in October as the deflation from July to October 2008 has been removed from the 12 month comparison and as consumer prices rose between July and October 2009. The big increase will however come in the two coming months.

Between October 2008 and December 2008, consumer price fell a seasonally adjusted 2.4% (before seasonal adjustment, the drop was 2.9%). This means that even if consumer prices are flat in seasonally adjusted terms, this would increase the inflation rate to 2.2%. Given a more plausible scenario where they increased 0.7% over two months (something which would require an unadjusted increase of just 0.1% each month), it would rise to 2.9%, above the 2% level that central banks target.

The euro area and most other economies can slso expect significant increases in their inflation rates though the increase will in in most cases be smaller because of the recent dollar weakness.

It could be noted that Mish and his followers have argued that the official CPI understates deflation because it uses "owner's equivalent rent" instead of house prices. I partially agree with that since it is house prices and not "owner's equivalent rent" that determines the cost of housing for home owners. However, Mish's calculations overstated this by first of all using the Case-Schiller index which likely overestimated house price declines as it only covered 20 cities, and not the larger number of smaller cities where the housing boom and bust was smaller and secondly because some of that price drop reflected reduced preference for ownership, something which means that the perceived value of owning dropped which in turn means that a quality adjustment would have reduced some of that drop.

The interesting here is that if you use house prices then the rise in inflation is even more significant (particularly if you ignore the two caveats I mentioned and use Mish's index in unaltered form), because for the fourth straight month in September, house prices have actually risen, causing the yearly drop to decline to the lowest level since late 2007. As the big monthly declines in late 2008 and early 2009 are gradually removed from the base in the 12 month rate of change, the yearly decline will drop fast in the coming months.

By contrast, the annual increase in "owner's equivalent rent" is dropping fast as it has been flat or falling for the last few months. As a result, inflation is recovering even faster using Mish's methodology.

For those of you who wonders how this acceleration in price inflation is consistent with the recent moderation in monetary inflation see here.