Greg Ip

Articles by The Economist’s U.S. Economics Editor

Dialing back the deflation watch

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In the tussle over whether deflation or inflation is the bigger threat I’ve been firmly in the deflation camp. In the last few weeks, though, I’ve tiptoed closer to neutral. Core inflation hasn’t dropped as much as I’d expected to date, and the drop that has occurred seems entirely due to owners’ equivalent rent. Goods prices inflation has been surprisingly sturdy.

Yesterday’s report by the Congressional Budget Office also prompted me to reexamine my assumptions. The CBO has raised its CPI inflation rate forecast for 2010 to 2.4% from 1.7%, while leaving the 2011 forecast at a still very low 1.3%. It marked down even more its forecast of inflation as measured by the GDP price index

The CBO says:

The projection of inflation (measured by growth in the PCE price index) was revised upward by between 0.3 percent and 0.4 percent over the next three years, in part because import prices are expected to increase more rapidly than CBO last projected, and also because excess capacity seems to be having a somewhat more modest impact on inflation than was previously thought.

(As an aside, this revision explains a lot of the reduction in the CBO’s 10-year deficit estimate from its August projection, to $6.7 trillion from $7.1 trillion. Higher inflation raises nominal GDP and thus revenue. The CBO also marked down its average interest rate forecast for that period, largely because the private sector did, too. This reduced interest costs.)

Some of the inflation revision is because of the lower dollar, which is putting upward pressure on prices of tradable goods. The CBO also seems to think higher unemployment is exerting less disinflationary influence than traditional estimates of this relationship, called the Phillips Curve, assume. Inflation hawks at the Fed and elsewhere have made this argument for some time; I find it interesting the CBO is giving it some credence since, like me, the CBO puts a lot of stock in the Phillips curve.

I haven’t switched my deflation alarms off altogether. Goldman Sachs has argued that most of the sturdiness in inflation to date reflects just four categories: gasoline, cars, tobacco, and medical care, and “only the last of these seems likely to repeat its contribution from 2009.” Moreover, the most direct evidence of the output gap’s impact is wage growth, which continues to slow.

But the odds of outright deflation, as opposed to very low inflation, seem to have diminished a lot.

The original post is linked here.


Written by gregip

January 28, 2010 at 6:05 am

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