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Economy in Brief

Will Stubborn PPI Core Give Fed Pause?
by Robert Brusca  September 13, 2012

The PPI is the most volatile and the least important of the "major" US gauges of inflation. Still it does send a signal and we prefer to look at the components of the PPI that will feed most directly into the CPI since the Fed places more emphasis on the CPI and even more on the PCE deflator. Core (ex food and energy) consumer non-durable goods at the PPI level are showing some acceleration over three-months compared to six months and touch of a boost compared to its Yr/Yr reading. Durable consumer goods (by their nature "core") are showing a clear acceleration. Even capital goods prices re hosing acceleration.

Inflation is important for what it is. It is one of the elements that the Fed "targets", the other being unemployment, the latter is a looser sense.

Still, the policy decision over QE that is on the table now for the Fed, bears on inflation in several ways. We all are aware, economist or not, the recession was severe and job creation has not kicked back into gear. The Fed Chairman is "worried" over the extreme duration of unemployment. He takes the high degree of unemployment (and the low levels of measured capacity utilization) as indications that the economy has a great deal of slack. With this view stimulating the economy should increase output rather than stimulate inflation. So in this model "inflation" serves as a litmus test for the degree of slack in the economy as well as a gauge for which there is a policy objective.

While the PPI is not what the Fed targets when it comes to inflation the PPI (its core at least) can serve the role of a barometer for the degree of slack in the economy. If the economy has slack, inflation should drop as unutilized resources put downward pressures on goods prices and factor prices (wages etc).

But this is not happening. There was debate at the FOMC about what would convince the so called "hawks" to be less fearful of over stimulus. One suggestion was that if inflation fell that should be taken as evidence of an effective GDP gap. But now that line of reasoning is all hypothetical. Year-over Year PPI core inflation is stubborn. Capital goods inflation is starting to accelerate, too. And the US exports a lot of capital goods those exports shoot out into a global economy with weak demand yet capital goods prices are accelerating. Consumer durable goods and non-durable goods inflation each are starting to accelerate. And this is happening without a great deal of demand in the economy.

If core inflation is the surrogate for the degree of slack in the economy it is not coming up with much of a reading on slack. Moreover, Bernanke has been telling us he is not in favor of more inflation and has pledged to not let inflation ramp up. The Fed may be ready to do more QE anyway as the PCE measure of inflation is still low. But the PPI is not on the sidelines cheering the Fed on. With the PPI in hand the "hawks" on the committee would be expected to stiffen-further their resistance to more QE. With elections coming, making a policy change seems politically risky. The Fed already has an extension of Operation Twist in play. It is hard to see how the Fed would justify more QE in this environment, especially when Bernanke just got through arguing in Jackson Hole that the hurdle for non-traditional policies should be higher. At 3.1% finished core consumer goods inflation at the PPI level is above the Fed's PCE ceiling of 2%. Of course, the PPI is not PCE and mapping from the goods portion of the PPI to the PCE and the CPI is very sloppy. But the PPI is not something that seems to align itself with market expectations for Fed action. The PPI may not be a reliable enough gauge to stay the Fed's hand, but for the moment it is a fly in the ointment.

Key Trends in Consumer Prices at Producer Level
  Aug-12 PPI Trends by Type of Good
  1Mo:M/M 3Mo:ar 6Mo:ar 1-Yr Yr-Ago
Fin Cons Nondurable ex Food & Energy 0.2% 3.6% 3.1% 3.5% 4.5%
Durable goods 0.2% 5.4% 3.4% 2.6% 2.0%
Finished Core Cons Goods 0.2% 4.4% 3.2% 3.1% 3.4%
Total PPI Core 0.2% 3.6% 2.8% 2.6% 2.6%
Capital Goods 1Mo:M/M 3Mo:ar 6Mo:ar 1-Yr Yr-Ago
Total Capital Goods 0.2% 2.5% 2.0% 2.0% 1.6%
Mfg Industries 0.1% 1.0% 1.2% 1.5% 2.0%
Non-Mfg Industries 0.2% 3.0% 2.2% 2.1% 1.5%
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