Duncan’s Economic Blog


Posted in Uncategorized by duncanseconomicblog on September 17, 2010

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.  



7 Responses

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  1. Will M said, on September 17, 2010 at 11:18 am

    chrissakes man, i thought you were at least going to edit this out of email format…

  2. Left Outside said, on September 17, 2010 at 12:11 pm

    A quick and dirty post of course, but did you mention the exchange rate? £ down, import prices up.

    • duncanseconomicblog said, on September 17, 2010 at 12:37 pm

      I was talking about the West generally rather than the just the UK, but yes another factor!

  3. Luis Enrique said, on September 20, 2010 at 12:24 pm

    you may be interested this article about the difference between pure inflation (all prices and wages rising) and changes in relative prices (i.e. oil and food becoming more expensive). There’s a link to a paper at the bottom of this article:


    it confuses the hell out of me.

    NB this isn’t directed at your post, just something related that I thought you might like

    • duncanseconomicblog said, on September 20, 2010 at 5:31 pm

      Thanks Luis.

      Interesting stuff as ever. I remember Mervyn King arguing in 2008 that we were witnessing a shift in relative prices rather than actual inflation, as oil raced towards $147.

      I think, as one ponders the dynamics of core versus headline inflation (not to mention asset price inflation), then the entire notion of CB inflation targetting becomes more difficult.

      • Left Outside said, on September 21, 2010 at 3:57 pm

        Frankly I’m beginning to like the sound of NGDP targeting rather than inflation targeting or level targeting.

  4. Bill le Breton said, on September 21, 2010 at 4:43 pm

    And M4 (Lending) still heading south-east on the B of E graphs. NGDP may indeed be the optimum target but because central bankers are very conservative it may be more productive to scream “What about the money supply?!” Not very long ago they were as keen as mustard on controlling inflation this way – surely they should see that deflation is also a monetary phenomenon.

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