A quick post. A friend emailed me today to ask what I thought of his view that deflation was still more of a threat than inflation.
This was my response:
But – energy prices (maybe driven by supply constraints) are increasing and are likely to continue to increase.
Similar issues with food (see this http://ftalphaville.ft.com/blog/2010/09/17/345981/china-1789-and-potash/ )
Possibly cotton to (which feeds into clothing, see Primark warnings the other day http://www.google.com/hostednews/ukpress/article/ALeqM5iCpYY9BEsMGEPKWk74528tL3-U4g ) although maybe that one is possibly short term.
We basically have a trade off between rising primary product costs, which is likely to continue, and stagnant wages.
Plus a general lack of corporate pricing power across the West as consumers are over stretched.
I would not be at all surprised if we ended up in a situation whereby core inflation (i.e. excluding food and energy) was falling but headline inflation remained broadly positive (even 3/4% or so).
This becomes self perpetuating. Given the low elasticity of food and energy demand, rising prices here act as a tax on other consumption, further reducing demand and further reducing prices.
We then have the worst aspects of deflation – falling corporate profits and probably rising unemployment, without the benefit of rising real wages.
Hhhhmm, I’m gloomy today.
Interesting to see how central banks play it. I’d have thought they need to concentrate on core inflation here – keep interest rates low. You can’t solve a supply problem with interest rates!
If they panic about headline inflation and raise rates (certainly possible), then the entire macro picture becomes even more scary.