Tomorrow's CPI release will say that headline inflation is negative. But that's not the same thing as deflation.

I'm not looking forward to tomorrow's CPI release. Not because I'm expecting bad economic news, but because I'm expecting bad economics journalism. (You may want to check out this post before continuing.)

Tomorrow's headline inflation number will be calculated as follows: take the June 2009 number, divide by the June 2008 number, subtract 1 and multiply by 100. This number will almost certainly be negative, but it will most emphatically be not a sign that Canada has drifted into deflation.

The reason for this is that in June 2008, there was a runup in gasoline prices. Between May and June 2008, the transportation component of the CPI rose at an annual rate of some 22%, and this brought the annualised monthly inflation rate of headline CPI up to 8.8%. Since then, gasoline prices have fallen, and so has the CPI. So when the June 2009 numbers are published, the headline rate of inflation will be calculated using a base of  114.8. In May 2009, the CPI was at 114.1, so the only way we could avoid seeing a negative year-over-year inflation number is if June comes in at 114.8 or higher - an annualised inflation rate of 7.6%. If that happens, the real risk is of inflation, not deflation.

So tomorrow and Saturday, expect to see dumb headlines such as "Canada slips into deflation" in the MSM. Try to ignore them.

Update: Gaaah! Andrew of Stackelberg Follower informs us that the barrage has already begun. I'm going to document a Hall of Shame of articles that make this predictable mistake. If you see something I've overlooked, please let me know in the comments.

1. A focus on deflation - Globe and Mail
2. Deflation raises its head for first time in 15 years - Globe and Mail. What the heck is "technical deflation"?

Update²: Credit where credit is due. I've already come across articles that got the story right, so here's a Hall of Fame. Again, let me know if you see others.

1. Canada seen starting brief deflation spell in June - Reuters. The article gets it right, but the editor who wrote the headline clearly didn't understand it.
2. Inflation below zero? It's happening now, but won't last long, economists say - Canadian Press. "This is more of a story of how high gasoline prices were a year ago than how low prices are today," explained CIBC chief economist Avery Shenfeld. Yay!
3. Inflation rate may go negative this week - Canwest.
4. Inflation turns negative, falls below zero for first time in 15 years at -0.3 per cent - Canadian Press. Economists have stressed that Canada does not have a deflation problem - a broad and prolonged period of falling prices - and that the dip into negative territory will be short-lived. Well done!

Comments

[anon]

And look for knock-on virus effects such as frenetic follow up discussions about the potential for quantitative easing, and reasons for why the stock market does whatever it ends up doing tomorrow. It's alive and its mutating!

[Chris]

Thanks for the heads up. I typically ignore headlines like that anyways, but thanks! I've mentioned your post on my blog too.

[Andrew]

I feel compelled to point out the Globe already has an article out on just this subject.

http://www.theglobeandmail.com/globe-investor/investment-ideas/features/at-the-bell/a-focus-on-deflation/article1221354/

[Stephen Gordon]

Gaaah!

[Declan]

As if any more proof of money illusion was needed!

[Declan]

(just in case it's not clear, yes I know the phenomenon here (mistaking cpi changes driven by oil prices for core cpi changes) is not the same as 'money illusion' (mistaking nominal changes for real changes) just that the mechanism of people acting 'irrationally' with respect to numbers even when theoretically you might expect them to know better is the same)

[Nick Rowe]

From Statscan:

"The Bank of Canada's core index advanced 1.9% over the 12 months to June, following a 2.0% rise in May.
The seasonally adjusted monthly core index increased 0.2% from May to June, after a 0.3% rise from April to May."

Now, if I remember correctly, weren't you complaining about a month or two back, Stephen, that StatsCan didn't publish the seasonally adjusted core CPI? Maybe they are reading WCI!

And with those numbers released today, plus the Bank of Canada recent survey that shows most businesses now expect inflation between 1% and 3% (fewer expected below target inflation, or deflation, than in the previous survey), I am now a lot less worried about the threat of deflation than I was a few months back.

(Just to be more precise, it is not deflation that worried me, but expected deflation, though, of course, either one eventually leads to the other.)

[Josh Hendrickson]

Reading this post, I am reminded of an interview with Allan Meltzer regarding deflation and he pointed out that few in financial journalism seem to realize that there is a distinct difference between a decline in the price level and deflation.