Economic Indicators And The Risk Of “Lowflation”

As we enter 2019, there are some economic indicators worth thinking about. Some are obvious, like the strong jobs growth (stronger than I expected). Some are more subtle. Here are wage inflation (blue) and core PCE inflation (red):

In my view, wage inflation is far more meaningful. But PCE inflation is what the Fed is targeting, so we also need to pay attention to that variable. I’d expect it to follow wage inflation, but the relationship is weak.

BTW, I noticed a problem with the way they calculate core inflation, at least for the CPI. It does not include food consumed away from home. In my view, restaurant meals are one of the most “core” of all core inflation components or should be. The whole point of core inflation is to include stuff closely related to wage inflation, which is very inertial. And yet food away from home (6% of the CPI) is considered part of “food and energy”, and excluded from the core. In contrast, I’m not sure shelter should be included in core inflation, as real estate price measures are not reliable. But this component (1/3 of the CPI) is a part of core inflation. This link gives the weights of the CPI basket. The CPI is just a mishmash of unrelated and hard to measure stuff.

This is one reason why I’m less concerned with “lowflation” than many other people. Wage inflation is steadily rising and is approaching pre-recession rates. We seem headed in the right direction.NGDP growth has also been strong.

Private forecasters predict roughly 2% inflation going forward, while the financial markets seem to predict less than 2%. How much less? That’s hard to say.

The 5-year TIPS spread is about 1.65%. But CPI inflation has exceeded PCE inflation by 0.25% over the past decade, so in fact, the true TIPS spread (for PCE) is around 1.4%, well below the Fed target. That may be partly due to two factors. One is the recent fall in oil prices. For various reasons including lags in adjustment, TIPS spreads tend to follow oil prices (the graph divides oil prices by 25, to make comparisons easier to see):

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