Monday, March 21, 2011

Inflation 6.6%?

Larry Kudlow reports:
Respondents anticipate prices to climb 6.6 percent over the next year. That’s double the 3 percent inflation registered in the December survey.

As the 30-year US Tbond yield is only 4.48%, and the 3-month yield is only 0.16%, if this happens, bond and Eurodollar markets will tank. I was shocked, but then I read the fine print, and this was a survey of 800 regular Americans, in other words, people who probably don't even know what the current inflation rate is (around 1.6% for CPI's latest year-over-year number). Among experts:
The Federal Reserve Bank of Cleveland reports that its latest estimate of 10-year expected inflation is 1.88 percent. In other words, the public currently expects the inflation rate to be less than 2 percent on average over the next decade.

If actual inflation, and economist expectations, are still around 2%, right now things are stable. But it still seems like we are drinking shots of Everclear until we become excitable, at which point there's a brief period of exhilaration, and then all sorts of pain. If economists do miss this it will be like their disastrous experience in the 1960s, where they were blindsided by the increase in inflation that decade. There were many stories of economists who then worked on macro-models and were sure inflation, and thus bond rates, would decline. They kept rising, and the next decade it only got worse.

Fed economist Eric Swanson notes a similarity between the 1960s "operation twist" and the current Fed initiative, QE2:
This paper undertakes a modern event-study analysis of Operation Twist and uses its effects to estimate what should be expected for the recent quantitative policy announced by the Federal Reserve, dubbed “QE2”. We first show that Operation Twist and QE2 are similar in magnitude.

Let's hope it's not too similar.


Anonymous said...

In the rare event that velocity snaps back to where it was before the Fed can do anything about it, inflation could get extreme. When you average that in, 6.6% isn't too insane.

I mean, conditional on that we are in the midst of a recovery, 4% sounds perfectly realistic to me.

Anonymous said...

Mr. Falken?

Pete S said...

The big difference between the 60s and now is that, in the 60s, they thought the Philips curve was a menu ... and they were willing to tolerate higher inflation.

Then they added expectations to the models, and we know that the Philps curve can shift up and down.

Mercury said...

The CPI is BS. For one thing food and energy really do matter to people and goods where food & energy are significant inputs. The hedonic wonderfulness of your better-for-cheaper Ipad2 doesn't actually pay the bills either. Also, they've frigged with the CPI calculation in the 80's and 90's and current inflation calculated with the original methodology is much higher than 1.6%. It sure seems like everything is a lot more than 1.6% more expensive than last year to me. Related:

Mercury said...

Oh, and this is cool too:

tfcooper said...

There is a market in inflation swaps, which will give you an accurate consensus forecast. If you really disagree with the market consensus, go long or short.

Talk is cheap.

Anonymous said...

There are alternate measures of inflation produced by non-official sources and the inflation rate appears to be higher than the official stats. One such source, John Williams of calculates the inflation rate according to the government's methods of decades ago (and which have been altered since) and comes up with some interesting results.