CPI: Deflation Watch

The September Consumer Price Index numbers are out. Inflation is really a sustained general increase in the level of all prices.  Since the price index itself can be rather noisy, varying a lot from month-to-month, many economists use some different techniques to smooth out the trend to see what the “sustained” action really is.  Three of the most popular ways of smoothing out the noise are called core CPI, median CPI, and trimmed-mean CPI.  In all three cases, the signals they are sending are not encouraging for recovery.  We are not yet into true deflation territory where prices are actually falling instead of increasing, but we are very, very close.  Both deflation and high inflation are undesirable.  But the risks are not symmetric.  Even very small amounts of deflation can be difficult to eliminate and can easily push an economy into a very prolonged period of stagnation or decline.  Inflation, on the other hand, can be more easily brought down if it gets too high.  Further, inflation at low levels, such as 2-4% isn’t very harmful at all.  In fact, a case can be made that 2-3% inflation is much more desirable than no inflation.

I like to think of managing inflation/deflation as driving down a desert road at the edge of cliff.  On the deflation side of the road is steep cliff with no guardrail.  On the inflation side of the road is a desert strewn with rocks.  Messing up and getting into inflation will get rocky and messy, but it’s manageable and survivable.  Erring on the side of deflation and things get real bad, real fast.   Best to leave a little margin of 2-3% inflation to make sure there’s no accidental plunge into real deflation.  For more than a year now, we’ve been playing daredevil with our economic futures by getting way too close to deflation.

Calculated Risk explains and offers one of their as-usual outstanding graphs:

…these three measures: core CPI, median CPI and trimmed-mean CPI, were all below 1% in September, and also under 1% for the last 12 months.

Inflation MeasuresClick on graph for larger image in new window.

This graph shows these three measure of inflation on a year-over-year basis.

They all show that inflation has been falling, and that measured inflation is up less than 1% year-over-year. Core CPI and median CPI were flat in September, and the 16% trimmed mean CPI was up 0.1%.

One last note about these numbers.  When The Fed increased it’s balance sheet dramatically two years ago to help bail out the banks and stabilize the financial system, the Austrians, Monetarists, gold bug types, and general austerians all complained that The Fed was leading us into a hyperinflation.  When the federal government budget blossomed into multi-trillion dollar deficit in early 2009, the same people warned us that it would lead to hyperinflation.  Now, 20-24 months later, we can conclude they were wrong. Their models are wrong and therefore the policy advice is wrong.  Deficits do not lead to hyperinflation when you have double-digit unemployment. Period.