Weighing The Week Ahead: Is It Time To Worry About Inflation?

This is exactly the kind of mistake I have been fearing. When tensions escalate and military action is employed, trigger fingers get itchy.

The Week Ahead

The economic calendar is a big one, featuring inflation and housing data. Retail sales is also important. The NFIB small business optimism has gained interest among those focused on business investment. Fed devotees will do a deep reading of the Beige Book. Michigan sentiment gives a clue about consumers. I am not very interested in the regional Fed surveys, but some data mavens follow them closely. There is something for everyone.

And perhaps of greatest significance, we get the start of earnings season. Brian Gilmartin has a preview.

Briefing.com has a good U.S. economic calendar for the week. Here are the main U.S. releases.

Next Week’s Theme

The market got a taste of the possible consequences from increased Middle East conflict. Much of the punditry was left amazed that the impact was not greater. Their business is discussing what to worry about, so they are wondering why their daily reports are not having a greater effect.

My biggest worry is hardly mentioned – at least outside of the doomster network. For years I have said that inflation news was not relevant but would be someday. I have also cheered for modest inflation levels while others sought an increase to the Fed target of 2%.

With this week’s PPI and CPI reports (and I don’t expect anything unusual) we have an occasion to think about what we should be watching. We should be wondering: Is it time to worry about inflation?

Background

Inflation is important for several reasons.

  • It is a foundation for Fed policy. Price stability is one half of the dual mandate.
  • Failure to act soon enough to deal with incipient inflation is the most frequent cause of recessions.
  • Inflation begets higher inflation expectations which beget lower market multiples.

There is a sharp contrast between the Fed’s analysis of inflation and that of the trading community. The wedge is further driven by constant commentary from the “reliably bearish” list on my Twitter feed. Last week there was a good illustration. One week ago Ben Bernanke, former Fed Chair, Former Chair of the Princeton Economics Department, and currently a Distinguished Fellow in Economic Studies at Brookings Institution delivered the 2020 American Economic Association Presidential Address. He takes on the question of very low interest rates and the challenges of 21st century monetary policy. Briefly put, he finds that the modern tools of central bankers are generally effective until nominal interest rates are lower than 2%. He highlights the need for cooperative fiscal policy. He gives a nod to the “victory over inflation under Fed chairs Volcker and Greenspan” and how this has created a new perspective:


In a world in which low nominal neutral rates threaten the capacity of central banks to respond to recessions, too-low inflation can be dangerous. Consistent with their declared “symmetric” inflation targets, the Federal Reserve and other central banks should defend against inflation that is too low as least as vigorously as they resist inflation that is too high.

The Twitter response to this was “Hasn’t he learned anything yet?” This take, supported by some bloggers and a staff member who had a cup of coffee at the Fed, apparently resonated with many of their followers. It is difficult to compare ideas when some are just seeking confirmation and page views.

By coincidence at the very time of Bernanke’s speech my former colleague Marty Finkler was circulating some of his thoughts on the role of central bankers. His final version, What Should Central Banks Do? Central Bankers Volcker, Mishkin, Rajan, and King Provide Excellent Guidance
explores the changing goals confronting central bankers. Not incidentally he describes the need for clarity from legislative bodies. He concludes as follows:

In my view, if monetary policy is left to politicians who are elected on a relatively short term basis, countries face incentives to manipulate monetary policy to serve short term ends. Such incentives are strengthened by recognition that the lag between monetary policy and output is much shorter than that between monetary policy and both inflation and financial fragility.We need the Paul Volckers of the world to sustain long term economic viability by targeting both price and financial stability.I, for one, recognize his contribution to economic vibrancy in the United States and mourn his passing.

With a knowledge of the differing perspectives and what is at stake, I will examine some specific points.

Goals

Since 1977 the Fed has had a dual mandate from Congress, to “promote effectively the goals of maximum employment, stable prices, and moderate long term interest rates.” (Richmond Fed). Public resources, some cited in the article, illustrate the policy in action. These include transcripts of FOMC meetings.

The popular take is quite different. The Fed is held accountable for providing income to savers. It is charged with creating asset bubbles and resulting market crashes. In current days there is a sense that the Fed will not allow market prices to decline below a certain level (referred to as the Fed “put”).

Inflation Target and Measurement

The Fed has announced a symmetric target of a 2% annual increase in the core PCE. They use the PCE because it emphasizes factors that have more economic relevance than the CPI. They use the core rate since it clarifies the underlying trends by removing two volatile elements.

The popular view is that of the many inflation measures, none of them is accurate. Individual experience always differs from the aggregate, so it is easy to find a large price increase to use as a criticism. And why 2%? Why not zero? [This criticism frequently comes from the same sources who are worried about a low return to savers!] At the extreme, some sources claim that inflation has exceeded 10% for many years.

What counts in the measurement

The Fed relies on government data concerning actual spending by consumers. There are many variants, but all include a collection of goods and services.

The alternative view is that asset prices should be part of the indicator. If stocks and commodity prices rise, this should be measured. Furthermore, it should be part of the Fed mandate to stabilize these prices, regardless of the economic consequences.

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