Friday, April 15, 2011

Inflation: Gaining Perspective

The Lehmann Letter (SM)

Today's report by the Bureau of Labor Statistics on March's CPI increase -- at a 6% seasonally-adjusted annual rate -- rekindled fear of surging inflation:

Take a look at the chart to put matters in perspective. You will see that in the 1970s inflation grew from 5% at the beginning of the decade to 15% at the end. That's surging inflation. We are nowhere near those conditions now.


(Click on chart to enlarge)

(Recessions shaded)

What happened in the 1970s and what would have to happen today to reintroduce an inflationary increase of that magnitude? The answer: In the 1970s runaway gains in household borrowing fueled double-digit price growth. In addition the economy periodically bumped up against full-capacity utilization, depressing productivity and boosting costs. That is, as consumers deficit-financed rising expenditures on homes and autos, production climbed beyond the point of diminishing returns -- raising costs and prices.

Today's economy is very different. We have slack borrowing, slack demand and plenty of slack in our productive capacity. It is true that rapidly rising overseas demand has escalated our cost of imports, especially primary products such as fuel. Unless domestic demand grows rapidly, however, there is a good chance that rising fuel prices will drain purchasing power away from other areas. When households spend more on gasoline, they have fewer resources available to purchase everything else. That depresses inflation in those areas as fuel prices rise.

If private-sector demand grows rapidly, made possible by steep gains in private-sector borrowing, that would bump inflation upward because consumers could spend more on fuel and everything else. (Just as they did in the 1970s.) But, once again, that has not yet happened. And it will take a great deal of borrowing and spending to reintroduce the inflationary climate from which we suffered decades ago.

(The chart was taken from [Click on Seminars and then Charts.] Go there for additional charts on the economy and a list of economic indicators.)

© 2011 Michael B. Lehmann

1 comment:

zhonglin said...

I agree with the point that CPI increasing during this season is not a sign of inflation, but the outcome of economic recovery. A single season’s data is not, by itself, a cause for alarm, but vigilance is needed to ensure that it does not foreshadow inflation. The situation is different from 1970s, because after the recession around 1975, the CPI was still more than 4%, but now, after the recession 2008-2009, the CPI at one time was less than -5%, so make sure the private-sector borrowing will not grow too fast than the speed of recovery, the inflation is not likely to come to anytime soon.