Deflation is on the horizon, but how far away is it?

The Canadian and US CPI numbers were released today. Here's what's been happening with the Canadian core CPI (which excludes energy, food and other volatile prices):

And here's the series for US CPI less food and energy:

I'm pretty sure that Mark Carney is glad that he doesn't have Ben Bernanke's job. The US is closer to deflation than we are, and the Bank of Canada still has 100 basis points to play with.

Comments

[Curmudgeon]

At what point does it become good public policy to implement the Zimbabwe solution 'quantitative easing' to fight deflation?

If the economy runs into inflation later then a) we can cross that bridge when we come to it and b) there's no limit on the ability of monetary policy to fight inflation.

[Adam]

"At what point does it become good public policy to implement the Zimbabwe solution 'quantitative easing' to fight deflation?"

How on Earth could it ever become good policy to simply print money willy-nilly? Is there a more efficient way of utterly ruining an economy?

"If the economy runs into inflation later then a) we can cross that bridge when we come to it and b) there's no limit on the ability of monetary policy to fight inflation."

Crossing that bridge when we come to it would probably involve a repeat of the brutal recession of the 1980s, when interest rates had to be jacked sky-high in order to get the money supply under control. And saying there's no limit on our ability to fight inflation is a little like saying there's no limit on the government's ability to wage war. Yes, but why on Earth would we want to court that option voluntarily?

[Curmudgeon]

Deflation describes a decline in the price level. Inflation describes an increase in the price level. Printing money causes inflation and can compensate for deflation.

No sane central banker would use quantitative easing in normal economic conditions but a deflationary spiral is far from a normal economic condition and the tools to manage the situation are poorly understood and range from bad to awful.

[pointbite]

Nobody is considering the possibility that we may be entering a new paradigm -- a new long wave cycle of higher savings and lower consumption that may last a generation. Baby boomers are retiring, their kids are watching Americans lose their homes by the millions and their parents' RRSP funds vanish and are thus becoming more conservative. Young adults are much more likely to stay at home well into their 20s and 30s than previous generations. Maybe we need to re-adjust our expectations, the old formulas may not work anymore. If people refuse to borrow, ZIRP won't change that, it will only force everyone to find other means of savings (other than dollar based). I don't usually link to my own blog, but in this case it's actually quite relevant, so I apologize for the shameless plug.

http://www.pointbite.com/2009/02/19/why-government-interference-may-fail/

I'm not really concerned about price deflation, we need to downsize the financial industry, and I don't think lending to businesses ("quantitative easing") will make the slightest bit of difference anyway. The best way to encourage savers to spend it to drop the prices, inflating them back up to levels the economy is not willing to support makes no sense. Instead of investing in capacity, invest in lowering costs, and move on.

I would be interested to hear your critique of my ideas!

[Patrick]

pointbite: Paul Krugman points out that history suggests that we're looking at something like 3-5 years to recover from a balance sheet recession. So, I think there is probably something to what you're saying, but it's not the whole picture. The emerging world has made huge advances. China is not going backwards, nor do I think will India, Brazil and many others. They will shift from NX to C and we will shift from C to NX. I view this as very healthy and hopeful. Many millions of people around the world could be lifted out of poverty as a result.

[Adam]

"Deflation describes a decline in the price level. Inflation describes an increase in the price level. Printing money causes inflation and can compensate for deflation."

Yes, obviously. But if you're suffering from chronic hunger, do you eat cotton balls or do you eat food? Both will get rid of that hungry feeling. It's just that one will make the problem even worse (although it'll fix the short-term issue) while the other will make things better.

If you want to stop deflation, address the underlying causes - don't just look for a quick fix.

[pointbite]

Patrick, if consumption increases dramatically in those emerging economies then Canada would probably flourish, as a major exporter of primary goods. However, that won't help the US. In that scenario, 3-5 years is very optimistic. De-coupling is a popular view and I hope it's ultimately correct; however, my skepticism lies not in the economics of the theory, but the politics. It can't happen unless the world makes a political decision to abandon the US dollar. As the US dollar plummets, all the lost purchasing power from American consumers will be transfered to people holding other currencies. Commodities will be rising against US dollars, but falling against everything else. So people abroad will have the capacity to purchase all the goods Canadians export. The risk is that people will lose confidence in all currencies and take the whole ship down...

Right now, all the circumstantial evidence I read from China tells a completely a different story. Shelves filled with products and workers outnumbering consumers. We'll see if the Chinese authorities smarten up before it's too late, because I think there is a time limit. If they wait too long, production capacity (for oil and everything else) will disappear and as demand returns even China will experience massive price increases in a new commodities bubble.

On the other hand, if emerging economies don't pick up the slack, then what? We must consider the possibility that demand will remain low for many years and living standards will drop, no amount of money printing can change that.

[Curmudgeon]

@pointbite:

You're not alone in worrying about the potential for the global crisis to metastasize into a permanent (or at at least permanent for the lifetime of anyone alive now) drop in living standards. Many people on the fringes of the public discourse--among them Jim Kunstler, John Robb and Dimitri Orlov--have been making these kind of arguments for some time now.

I agree the US is in a serious shithole--the situation is bad enough that there's no polite way to describe it--with little to no prospect of turning around towards economically sustainable (non-bubble) growth for at least a decade and quite possibly much longer. Much of this is due to the collapse of effective governance in the US; there are not even any glimmers of light on the horizon suggesting that the US political elite is aware of the problem, much less prepared to deal with it. Until the US is prepared to fix its government, its economic woes aren't going to go away.

If the rest of the world does not decouple to the point of replacing Americans as the consumers of last resort, then we're looking at a global recession lasting for however long it takes for the US to get its act back together. Nobody can provide a precise and honest estimate of how long it will take for the Europeans, Chinese, Indians, Japanese and Indonesians to form a global demand sink on the scale of American consumers circa 1997-2007 but it could well take longer than the lifetime of anyone alive today.

Put bluntly, there's no guarantee that economic conditions for westerners are going to improve above mid 2000s levels on a humanly meaningful timescale.

[calmo]

Blush...can someone tell me how to read these graphs? I cannot make head nor tail of the "previous _ months".
What happened to Canada ~Dec 07? (possibly the "previous 12 months" excepted)

Does the CPI in Canada follow the US model of using an OER proxy for housing costs?

Why is the Canada series so much more volatile?

Is this comparison immune from fx volatility (that saw the CAN$ reach parity with the US$ and then a few weeks later back to 0.80)?

Could it B true that Canada's economy is not in deflation? Lumber, oil, autos, tourism...did I miss something? Beaver pelts...hockey sticks...mosquitos...

Last thing: can we see a graph of California and Canada comparison?

[Stephen Gordon]

The annualised inflation rate for the previous 12/6/4/3 months is 100/200/300/400 times the relative change in the CPI over the previous 12/6/4/3 months. The 12-month number is the usual y/y rate.

What happened in Dec 07 is that the Canadian dollar hit parity with the USD, so you didn't have to do much in the way of arithmetic to realise that Canadians were paying more than Americans for the same products. A consumer revolt forced a one-time drop in prices.

[calmo]

Thanks Stephen, so the point of posting the 6, 4, and 3 month CPI annualized changes is...for those microeconomists who are reluctant to leave their shorter time frames?
Maybe it is to illustrate the fact that the CPI stats are not "seasonally adjusted"?
Ok, I don't do well with arithmetic at the best of times, but IIRC, the parity period was much shorter than depicted here (3-4 months?), and quite asymetrical, yes? (taking mere days to resume the .80 cents when it took several weeks to reach parity as the US$ took a global hit, no?)
Does this Dec 07 dip tell us something about the role of fx, (not the role of Canadian consumers in revolt) in CPI measurement?

[Bailey]

I know I 'm a little late to this thread but one thing I've been trying to figure out is why food prices are still rising. I know it made sense over the last few years with the rising cost of oil but oil has been dropping for a bit now. Is it just a lag effect on the previously high price of oil? Or is it a reflection of a lower dollar in Canada? I don't remember reading of any large supply issues besides the ongoing drought in Australia. Anyways, I've been puzzled the last few days regarding the price of food.