Economic Preview: Is inflation ever coming back?
The first full week of 2018 brings a raft of fresh economic data, including December retail-sales figures that will help investors gauge the state of the “retail apocalypse” in America.
But the main attractions for economists will be reports on inflation: The producer price index, which measures wholesale inflation, due out Thursday, is to be followed on Friday by the consumer price index, which tracks how much ordinary Americans pay.
That’s because inflation is the most important metric for the Federal Reserve — and its failure to materialize so far is, for the central bank, the most vexing aspect of an otherwise healthy economic cycle.
Inflation sounds scary — and it was, for anyone who lived through the period of the late 1970s and early 1980s and remembers prices spiraling out of control.
But inflation is also an barometer of economic growth. As long as it’s advancing moderately, it’s not only a sign of a healthy economy but also a signal to consumers of that health, which encourages them to shop and borrow before prices rise too much, which in turn keeps the economy humming — you get the idea.
Here’s how the Fed puts it: “Over time, a higher inflation rate would reduce the public’s ability to make accurate longer-term economic and financial decisions. On the other hand, a lower inflation rate would be associated with an elevated probability of falling into deflation, which means prices and perhaps wages, on average, are falling–a phenomenon associated with very weak economic conditions. Having at least a small level of inflation makes it less likely that the economy will experience harmful deflation if economic conditions weaken.”
In 2012, the Fed decided to put a number on those expectations. Like many central banks around the world, it now targets 2% annual inflation.
The central bank’s favored gauge of inflation, the index of personal consumption expenditures, isn’t released until the end of the month, but the two reports out next week will help give a general sense of how inflation is behaving.
So far, it doesn’t seem encouraging. MarketWatch’s forecast won’t be final until early next week, but early polling shows economists expect a monthly gain of 0.2%, with an annual gain of 1.7%, in the core consumer price index — that is, the price index without the particularly volatile components of food and energy.
And if inflation continues to be tepid, the question for the Fed will be, “What next?”
Policy makers have been saying for years that it’s “transitory” factors — everything from the carnage in the oil markets in late 2014 to falling cellphone-plan prices — that are keeping a lid on inflation.
Many economists agree, and some think 2018 is the year when the U.S. economy finally breaks free of the torpor of the post-crisis period. In a report titled “Timing the Transition from Reflation to Inflation,” BCA Research noted that it expects inflation to return to the Fed’s target by the second half of the year.
“Wages and prices generally lag real growth. Sustained real growth in 2018 should consequently shift wages to a higher trajectory,” said Steve Blitz, chief U.S. economist for T.S. Lombard, after December’s rate hike by the Federal Open Market Committee. “Wages could in fact accelerate more quickly than markets are pricing in, considering how the economy is picking up with labor-market supply at its tightest point for this cycle. The prospect of a quick upturn in wages is reason enough for [an increase in the federal funds rate], even though measured inflation remains low.”
But for every economist who is convinced that this time is different, there’s another, more cautious take.
“I’m not sure why anyone would get too excited about the sustainability of inflation in a world where price killers like Dollar General DG, +0.66% intend to add 900 new locations to its cache of nearly 14,000 stores — at a time when other retailers are scaling back,” said David Rosenberg, the often-bearish chief economist of Gluskin Sheff.
Rosenberg has hammered at the no-inflation theme in his morning note every day in 2018. “From my lens, if we get hints of an upturn in inflation,” he wrote Thursday, “then a new and inexperienced Fed seeking to establish its credentials [is] going to up the pace of [its] rate hikes.”
And as economists are well aware, expansions don’t die of old age — it’s often the Fed that kills them.