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Economy in Brief

Yr/Yr Inflation Edges Higher In The Zone...Central Banks Everywhere Feel The Pressure But What Pressure?
by Robert Brusca   September 30, 2010

The headline rate of inflation that the ECB puts a ceiling on rose by 0.2% in Sept after rising by 0.4% in August. The three-month pace of inflation is an excessive 2.4% with the Yr/Yr pace at 1.8%, still below the ECB's self-imposed ceiling. Inflation trends show that the overall rate of inflation is creeping up on the ceiling rate but that the rate of change for inflation's acceleration has slowed. Core inflation is just at a 1% pace Yr/Yr, just as it is the US. Still all that says is that the bulk of the rise has been outside the core and the ECB does limit the headline and not the core.

The headline rate of inflation that the ECB puts a ceiling on rose by 0.2% in Sept after rising by 0.4% in August The three-month pace of inflation is an excessive 2.4% with the Yr/Yr pace at 1.8%, still below the ECB's self-imposed ceiling. Inflation trends show that the overall rate of inflation is creeping up on the ceiling rate but that the rate of change for inflation's acceleration has slowed. Core inflation is just at a 1% pace Yr/Yr, just as it is the US. Still all that says is that the bulk of the rise has been outside the core and the ECB does limit the headline and not the core.

In this environment central banks are struggling with the question: "should we do more"? In the UK policy debate Adam Posen is an advocate of doing more Q-easing by the BOE .In the US Paul Krugman and FOMC voting Member Eric Rosengren also are advocates of more.

Posen likens the argument that we have ‘done so much' and the idea that we have 'done more than before' to arguments that are irrelevant. He claims that it's like saying we drove through a full tank of gas and didn't get there so why fill up and drive some more? Krugman argues that US deficits are large and they will linger so having more fiscal stimulus is sensible to diminish actual deficits. Action that makes the deficit larger now will make it smaller later. Rosengren argues that the Fed is missing on both its mandates with inflation too low and growth too low as well, so it should do more even if it has no potent weapons left.

These are taken as arguments for more stimulus and more quantitative easing. But are they really? In Posen's example the problem is that we know where we want to go but we have no map. So how long should we drive hoping to stumble on our destination by chance? Surely even without any direction the more we drive and the more we fill the tank, the more likely that we get where we want to go. Yes, true but very inefficient. Rosengren's argument is a bit different since one key pillar of his position is that inflation rates are too low. However, when the Fed talked about inflation targets it was considering a ceiling of 2% just like other W. European central banks. The Fed does look at core inflation and if it had a target it would target the core.

But, with various measures of the core near 1% it's hard to know how the Fed could characterize the middle of its target zone (2% to Zero) as the bottom, but that is the substance of Rosengren's argument. The Fed has no formal inflation target but inflation is currently on the forecast path provided by FOMC members when they last publicized their outlook and that outlook included an upswing in growth in 2010 and 2011. So what has changed? Not inflation, regardless of Mr Rosengren's argument or the Fed's last statement. But clearly this is the characterization the Fed wants to apply to inflation to empower a decision it seems already to have made. With two new governors just approved Bernanke would seem to have the votes in hand.

In England the argument is still in play against background of fiscal contraction.

At the ECB lips remain sealed but with community growth so disparate I think even the hawks there can see it's too soon to stir things up. In any case while we can argue about bank reserves only in the UK is actual money growth strong.

Central bankers are a clever bunch. But the facts must speak to the policy. In the US low interest rates are not helping much because as the Fed pushes the long term interest rate below its perceived equilibrium level, demand for credit is higher bur supply is diminished. Bankers are reluctant to lend. It's no accident that home refinancing takes longer and longer- banks are trying to ration these loans to those with lots of home equity, huge down-payments and the most stellar credit ratings; lending has become a circus of non-prices rationing. It's a way to discourage borrowers.

Nonfinancial corporate America has disintermediated and gone to the capital markets to raise funds and lock in low rates. But some do not need the money and plan share buy-backs and other corporate finance actions. There may be some positive feedback loops to rising stock prices and growth but it's not though any populist channel.

On balance headline inflation is snaking up. Interest rates are low and core inflation remains moderate, maybe it is edging lower, maybe not. Central banks have no direct idea what to do but they do NOT want to be structurally interventionist so they want to risk decades of inflation progress to pump reserves in as away to jump start growth without any clear idea how that will work or what damage control may look like if it does work. Doing it by revving up inflation expectations seems foolish. There are other possibilities and probably the fiscal authorities should be stepping up here. Monetary policy can carry only so much of the load and when we see our best and brightest central bankers arguing about how many bank reserves can be balanced on the head of a pin you know that something is wrong.

Trends in EMU HICP; Flash Index
  % Mo/Mo % SAAR  
  Sep-10 Aug-10 Jul-10 3-Mo 6-Mo 12-Mo Yr Ago
EMU-13 0.2% 0.4% 0.1% 2.4% 1.3% 1.8% -0.3%
  Core #N/A 0.2% 0.1% 1.8% 1.6% 1.0% 1.2%
Goods #N/A 0.1% -1.2% -4.6% 2.4% 1.7% -1.5%
Services #N/A 0.3% 0.9% 5.4% 3.3% 1.4% 1.8%
HICP
Germany 0.2% 0.2% 0.1% 1.9% 0.6% 1.3% -0.5%
France #N/A 0.0% 0.1% 0.4% 0.6% 1.6% -0.2%
Italy 0.1% 0.5% -0.1% 1.8% 1.6% 1.6% 0.4%
Spain #N/A 0.4% 0.5% 3.2% 2.4% 1.7% -0.7%
Core:xFE&A
Germany #N/A 0.4% 0.0% 1.9% 1.5% 0.6% 1.2%
France #N/A 0.1% 0.2% 1.6% 0.7% 0.8% 1.4%
Italy #N/A 0.5% -0.2% 1.5% 2.0% 1.7% 1.2%
UK #N/A 0.3% 0.0% 2.2% 2.6% 2.7% 1.9%
Spain #N/A 0.2% 0.4% 3.9% 2.1% 0.9% 0.5%
Blue shaded area data trail by one month
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