In a speech in Phoenix in early November, Governor Palin warned that inflationary pressures were on the rise, particularly in the food and energy sectors. She also noted that Ben Bernanke’s plan to print another 600 billion to as much as 1 trillion dollars via his QE2 plan would only exacerbate the problem, as monetizing the debt always does, and advised him to "cease and desist" from this ill-advised scheme. This prompted the hapless Sudeep Reddy to cry foul and claim, essentially, that there was no inflation. Governor Palin promptly took Reddy to the woodshed, an exchange Palin won going away. Even Reddy’s employers at the Wall Street Journal agreed with Palin on the inflationary dangers posed by a devaluation of the dollar. In a subsequent Facebook Note, Governor Palin elaborated further, taking to task those who would weaken the dollar as a magic potion to grow the economy via an increase in exports:
Will driving the dollar down in this way do anything to boost U.S. exports? The short answer is not really. A weaker dollar will temporarily boost exports by making our goods cheaper to sell; but inevitably other countries will respond in kind, triggering the kind of currency wars economists are warning us about. It’s precisely to prevent this scenario that World Bank President Robert Zoellick recently came out in favor of some new type of gold standard or “international reference point.”
Governor Palin was correct, of course, in questioning the efficiency of focusing on weak-dollar driven exports as a useful policy prescription for long term economic growth. In a previous post, I discussed, among other things, the lack of empirical data to back up this tactic. In any case, Governor Palin’s inflation concerns were further vindicated yesterday with the release of the latest inflation data, via Ron Scherer at the Christian Science Monitor:
The warning flags on the inflation rate are starting to flutter.
Higher food and energy prices helped propel the Producer Price Index (PPI) up by 1.1 percent in December, the Labor Department reported Thursday. This is the biggest monthly change in the past year.
On Friday, when the Consumer Price Index for December comes out, economists will watch to see if the price hikes for manufacturers have been passed through to consumers. Wall Street expects the report will show a rise of 0.4 percent for the month.
…food and energy prices have been higher than anticipated, and that could push the figure up to as much as 0.7 percent, which is an annualized rate of 8.7 percent, predicts economist Joel Naroff of Naroff Economic Advisors in Holland, Pa.
Rising food and energy prices for consumers have larger implications for the economy. Both involve products that most consumers need to buy. Thus, any increase in their prices pulls money out of shoppers’ disposable income.
“The rising food and energy costs tell me the first quarter is going to be uglier in terms of gross domestic product growth,” Mr. Naroff says. “I am already starting to mark down how fast the economy is growing.”
The CPI for December, to which Scherer refers above, came in slightly higher today than Wall Street expected at .5%. These numbers may sound benign, but they represent a significant increase over prior months and are an ominous sign for the future of the nascent economic recovery struggling to gain steam. Rising food prices in India and other nations are increasingly problematic. But much of this is missed since, significantly, official inflation data doesn’t tell the entire story:
But when economists, including Federal Reserve officials, talk about inflation, they often focus on a measurement of price pressures called "core" inflation. Core inflation excludes costs of food and energy goods, the very items that are the most visible prices for most consumers.
The theory is that food and energy prices historically have been subject to wild swings. Therefore, to get a better gauge of the underlying trend, you should cut those items out.
Excluding food and energy prices from core inflation, of course, is nothing new. But the benefit of removing the volatility inherent in food and energy prices from official inflation data doesn’t outweigh the resulting cost of inaccurate information, and has therefore never made a whole lot of sense to me. To be sure, the volatility issue is legitimate, but simply eliminating those vital items from the calculation results in, at best, an incomplete picture. While the BLS economists can simply "cut those items out", consumers can’t.
The demand for food and energy is inelastic. Elasticity is a term economists use to describe how sensitive demand is to a change in price. When a product is characterized by inelastic demand, rising prices don’t change consumer habits significantly. Energy and food are necessities. I have to have both to survive, regardless of how much they cost. For example, if gasoline prices rise to $5 per gallon as some are predicting (don’t expect any help from OPEC), I still have to buy it. Indeed my consumption of gasoline will not be significantly different than it was at $2…I don’t drive just for the sake of driving. Nor will I buy less food when prices rise. I still have to eat. The net result is that I’ll simply spend a greater proportion of my budget on food and energy, and less on those items which I don’t need to survive (what economists call luxuries) such as big screen TVs and vacations. How this benefits the economy is something Obama will have to explain sooner or later.
And yet these two crucial products are not included in core inflation. This, conveniently, allows government officials (in both parties) to claim inflation is non-existent while those of us who consume energy and food (i.e. all of us) are left scratching our heads. Sudeep Reddy’s objection to Governor Palin’s inflation admonition two months ago was based entirely on an illusion. But outside of the ivory towers in the New York / DC corridor, where Governor Palin and the rest of us live, we can’t ignore food and energy prices simply because they’re volatile and therefore not included in "core" inflation. The fact is that prices of those goods and services that people need on a daily basis are rising at an increasing rate, and the policies of the Fed and Obama Administration are only exacerbating the problem, as Governor Palin predicted they would.
(h/t Dave C)