Wednesday, January 20, 2010

Deflation Watch (December 2009): Price Level Trends Relative to Past Debt Crises

This is another update (with November and December's data added) to the series of posts on US price level trends that started with Price Deflation Today versus the Great Depression and Post-1990 Japan — Comparative Charts (which had data through July 2009). The original post contains the most in depth discussion of the comparisons between the three episodes, so please look at that if you have not already.

This one will be briefer than sometimes as I want to focus on some new topics (on which I will post in the future).

In summary, headline consumer price level increases seem to be slowing markedly following their sharp early 2009 rebound from the late 2008 plunge levels. Clearly we have not followed the path of Great Depression deflation, but the US price level trend appears to be flattening out much sooner than occurred in Japan, as the graphs below show. While mild deflation may be more probable, we could still be at some risk of a sharp price deflation, in part because commodity prices in particular seem (to this observer among others) to have risen too far too fast. A lot may hinge on the combined questions of (1) how much investor speculation in commodities (which is subject to quicker reversal than end-user demand is) has impacted their prices, and (2) how much and how abruptly China's growth slows. Though of course other factors such as the direction of broader asset prices (stocks, housing) and government policy are also very relevant to the CPI outlook.

These are my definition related comments from a previous post:
As noted previously, "deflation" is often discussed in broader terms than simply price level:
  • Contraction of money and credit (broad money supply)
  • Deflation in asset prices
  • Deflation in a representative "basket" of consumer and producer prices
  • Deflation in wages
The various measures are often somewhat correlated but they only track to each other loosely. In the Great Depression prices fell faster than wages, yet wages (along with asset prices) still fell enough to propagate the adverse feedback loop of debt deflation in which income falls but debt obligations remain at the same nominal level, increasing the burden of the debt. Deflation in asset prices (triggered by the bursting of debt-financed asset bubbles) generally precedes the other deflationary trends.
Some Relevant Current Articles
Price Level Charts for October

CPI-U 12 Month Changes (source: BLS)

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I think the year-on-year graph is deceptive when prices are as volatile as they have been. Compare it to the price level trend graphs below.

BLS Summary Comments:
"On a seasonally adjusted basis, the December Consumer Price Index for All Urban Consumers (CPI-U) rose 0.1 percent, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the index increased 2.7 percent before seasonal adjustment.

The seasonally adjusted increase in the all items index was broad based, with the indexes for food, energy, and all items less food and energy all posting modest increases. Within the latter group, a sharp rise in the index for used cars and trucks was the largest contributor to the 0.1 percent increase, while the indexes for airline fares, apparel, and lodging away from home rose as well. In contrast, the indexes for rent and owners' equivalent rent were unchanged and the index for new vehicles declined.

Grocery store food indexes showed broad-based increases, leading to the food index rising 0.2 percent, its largest one-month advance in over a year. The energy index also rose 0.2 percent; this was its smallest increase in five months. The indexes for fuel oil and gasoline rose, but the electricity index was unchanged and the natural gas index declined."

16% Trimmed CPI

This chart of 16% trimmed mean CPI (generated from the Cleveland Fed site) removes the most extreme monthly price changes:

(click on chart for a larger version in a new window)

Consumer Price Index Trends: Great Depression versus Today through December 2009 (US)
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Components of US Consumer Price Index (May 1927 - Dec 1937, Great Depression)
(Note: This chart is unchanged from past posts)
(click on chart for a larger version in a new window)

Components of US Consumer Price Index (January 2006 - December 2009)
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Annualized 3-Month Rate of Change for Components of US Consumer Price Index (April 2006 - December 2009)
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The above chart shows the rate of change (over a sliding three month period) of the components whose absolute price levels are shown in the previous chart. I also added the magenta line for shelter (even though it is contained within the yellow housing measure) to better show the effect of declining rents and owners' equivalent rents separated from other housing components such as energy.

Price Index Changes: Great Depression CPI versus Current PPI through December 2009 (US)
(click on chart for a larger version in a new window)

Consumer Price Index Trends: 1990s Japan versus US Today (through December 2009) and US Great Depression
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Note that the year on year graph higher up is deceptive, as inflation seems to be slowing much faster than occurred in Japan post-1990.

CPI in Japan (Jan 1980 - Jul 2009)

From previous posts: "The peak of Japan's CPI occurred in October 1998, almost eight years after the stock market peaked, and Japan's notorious mild deflation has been in effect since then. A multi-year disinflation (of core CPI) leading to sustained mild deflation is one possible outcome for the US.
(click on chart for a larger version in a new window)

Factors Contributing to Deflation

I had included a series of graphs of factors that contribute to price deflation such as capacity, wages, etc. I may re-include these in the future, time permitting and if they are of interest.

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