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Economy in Brief

The Return of Godzilla...the Rate of Inflation; That's Right- It's Not Science Fiction
by Robert Brusca  October 13, 2022

If there are any inflation deniers out there, it is well past time for them to 'man the lifeboats' and make an emergency evacuation from this point of view. Inflation is raging and is accelerating sharply. In Germany – once a paradise of solid price stability- inflation over 12 months is 11% rising, at a 10.6% pace over six months -barely indicating any abatement, and then jumping to a 16.2% annual rate over three months. These are not just accelerations of inflation from a depressed base. One year-ago the German HICP was up by 4.2% year-over-year. At the time, people were arguing that inflation rate was distorted. Ha! Little did they know…

Of course, Germany is not in control of its own inflation rate anymore the way it once was because it's part of the European Monetary Union and tied into this basket of countries that has different inflation tolerances and different economic and fiscal arrangements as well.

EMU is what it is...
The European Monetary Union is a monstrosity formed based on an idea by Robert Mundell on something he called an 'optimum currency area (OCA).' And like many things in economics, this concept was used to justify the formation of a 'European Monetary System' even though the members of this system do not qualify as an ideal OCA based on the criteria that Professor Mundell had set forth for such a union to be successful. For one thing, in their zeal to have a common currency, Europe was never ready to pull its fiscal fortunes together. There is no overarching fiscal policy as each country runs its own fiscal house although there are rules that can be used to bring countries back to fiscal morality when they stray. The reality, however, has been that it is only in the wake of Europe having employed this rule to discipline fiscal laxity that countries were put under severe stress and pressure and the European Central Bank eventually was pressed into service to make policies that have been far more inflationary than anyone would like to sustain the union.

German inflation and recession
The German domestic inflation rate is officially put at 10% and there's a new record pace of inflation since Germany has been reunified. But for those of you who remember history, we know that Germany has suffered far worse inflations than this as Germany's hatred of inflation stems back to its pre-War era of hyperinflation. The Bundesbank now looks for Germany to enter recession and it also recognizes that inflation is too high, and it urges - and expects - the ECB to be raising rates by another substantial amount at its next meeting. However, quite clearly the toothpaste is out of the tube. The Bundesbank argues that the economy will suffer a recession, but it will not be a severe recession. That's a curious argument. When we combine the notion of recession in the German economy with the ECB raising interest rates sharply, and with the energy shortages being experienced, it's hard to know why the Bundesbank would want to stick its neck out to say that the coming recession would be relatively mild. It seems that the risks are for relative severity.

Inflations in Germany is broad – not isolated or concentrated
Inflation diffusion for in Germany in September shows inflation went up across about 59% of the categories; this is a sharp acceleration from August where it went up in only 31.8% of the categories; in July it went up in only 9.1% of the categories. During these three months, Brent oil prices measured in euros fell by 5.3% in September, by 6.8% in August, and by 7.3% in July. We know that oil prices don't get into the CPI index immediately, but this has been a period in which oil prices are falling. In fact, oil prices fall on balance over six months and over 12 months. Yet, the inflation statistics for Germany are ugly

The inflation diffusion across categories over three months, six months, and 12 months shows inflation extremely broad on the order of 70% to 80%. That means over those time horizons inflation (annualized) is rising in 70% to 80% of the major CPI categories. Specifically, I calculate diffusion as derived from the three-month percentage change compared to the six-month pace and then the six-month pace compared to the 12-month pace, and then 12-month pace compared to the pace over 12-months in the comparable month of one year-ago. On all those comparisons prices are broadly accelerating across CPI categories.

Core inflation accelerates
Core inflation for the HICP rises from 6.3% over 12 months to a pace of 8.4% over six months to a pace of 12.6% over three months - those are all annualized rates and they're all extreme. The domestic CPI excluding energy accelerates from 6% over 12 months to 7.8% over six months to 11% over three months also showing sequential acceleration, the same message as from the HICP core.

Inflation has spread faster than Covid
Germany's statistics on inflation come out and finalize the same day as the U.S. has released its CPI that poured forth more bad news on inflation. Inflation has gathered pace internationally, even in countries that thought they had beaten inflation into submission. Inflation pressures, like in the Stephen Spielberg movie, Poltergeist... “they're back!”

Inflation is not a guy in a rubber suit
The inflation problem is real. It's not like the science fiction monster Godzilla that will go around and wreck Tokyo and make that look realistic but then later we find out, oh, that was only Hollywood or that was only a model or that was a guy in a rubber suit. Inflation is not a guy in a rubber suit. Inflation is real.

Huh? Transitory
Central banks are making policy by assuming that a good part of inflation remains 'transitory.' I say this because central banks with interest rates still well below the current rate of inflation continue to talk as if modest increases in the level of current interest rates are going to succeed in making monetary policy restrictive. And that can only happen if inflation falls sharply. And with central bank interest rates well below the rate of inflation, it's quite clear that central bank interest rates are not the things that are going to drive inflation down. If inflation is going to come down, it will be driven down by something else; it'll be driven down because it's 'transitory.'

Arm-chair inflation-fighting
Instead of central banks going out and being aggressive and moving interest rates up to a position where they can clearly push inflation lower, they are sitting back in their arm-chairs waiting for inflation to come down and at that point they expect to have moved interest rates up enough that monetary policy will eventually become restrictive and they can argue that they are then fighting inflation. But it's even more than that… In fact, by positing (forecasting?) enough of a declining for inflation, they can argue that expectations for future inflation are the right way to judge their policy so their policy which right now has interest rates well below the inflation rate, it actually is already restrictive because interest rate levels are restrictive relative to 'expected' inflation (next year!). And if you never saw a dog chasing its tail, you can read the sentence above and understand exactly what it's like!

Behind the eight-ball
Everyone continues to look for inflation to fall. Central banks are aggressively attacking inflation with open mouth policy…. but with actual monetary policy -not so much. Central banks can point to somewhat vigorous increases in interest rates, but this is only because they had allowed interest rates to stay so low for so long and allowed inflation to creep up then explode without taking any action at all. So that has left them with a long way to go and now they want us to acknowledge their vigorous moves higher. However, those moves still leave them behind the 8-ball instead of being in the right position to fight inflation.

Is inflation fighting an act of policy or an act of faith?
Inflation fighting remains as much an act of faith as an act of policy in the world economy currently. However, to read anything in the financial press, you would think that central banks were boogeyman who were raising rates at an enormously fast pace that was going to damage the economy. In fact, the opposite is true. If central banks don't continue to raise interest rates and raise them enough, there will be severe damage to the global economy because inflation is going to become entrenched; it may already be entrenched. I don't think the data on expectations can be trusted in part because the central banks have been hoodwinking the public about what's going to happen and how effective their policies are going to be. People are now suffering inflation shock. Clearly central bank policies have not been very effective and central banks are left chasing an elusive inflation rate, despite these recent ‘best efforts.’ Policy continues to fail to gain ground despite what are now fast-running central banks. No matter how fast you run if your opponent is faster, you get farther behind. Running fast my not be the solution, you may have to run even faster… That's a simple observation. Good luck to everyone. Believe what you will.

Commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
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