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Economy in Brief

Inflation Percolates Globally: Is It Really Transient?
by Robert Brusca  July 20, 2021

German producer price inflation rose by 1.3% in June; that's month-to-month not year-over-year. It's a huge change from the way things used to be, especially on the heels of a previous month-to-month gain of 1.5% in May. To have PPI prices up by between 2.5% and 3% over just two months is something that had been unthinkable until this post-Covid period swept into town. Covid slammed the global economy hitting countries more or less at the same time. This means that any stress it imparted would have been be magnificent because it would play out globally on the same timeline causing the effects to multiply because of common repercussions. 2011, in the wake of the Great Recession, was the last time PPI prices flared like this and at that time only the U.K. saw greater pressure than that it is seeing now.

The comparison to the Great Recession period is a reminder that after recessions, which are periods of suppressed activity and usually of diminished price gains, the economy tends to gain speed and push prices and activity back toward normal. In 2011 that process was in comparative slow motion, but it still drove PPIs up globally in unison – but not as fast or in as tightly coordinated as in this cycle.

In this round the recession, at least in the U.S., has been deemed over. It is so short I'm not sure it deserves to be called a recession if it is one what puts it over the hurdle is the clear depth and breadth of it – not the length. The recession in the U.S. is now deemed to the over as of April 2020. The recession was artificially forced upon the economy by government mandate to 'stop the spread' of the virus. So is that a recession, or is that economic policy in action?

Interestingly, there are two very important concepts in economics that lack precise definitions, and we are talking about one of them now. Recessions do not have precise definitions. They are in the U.S. declared on and off by the recession Dating Committee of the NBER. That committee considers three metrics: (1) the breadth, (2) the depth, and (3) the length of an economic event. Certainly, 2012 was a recession on two of those metrics. But what about the third, length? Can recession really be only three months long? And if it is engineered by the government, is it really a recession? The second vague economic concept is one we will puzzle over for some time: inflation. Inflation is simply defined as 'an ongoing increase in the prices level.' There is no period over which inflation is measured to ascertain this. There is no amount of increase that defines a threshold. Any ongoing increase in the price level is inflation. Of course, central banks do not try to prevent inflation; they try to suppress inflation to what they deem an appropriate pace and they call that 'price stability.'

In the case of Germany, we see solid PPI correlations between oil prices and movements in the PPI price level or inflation rate. The German CPI is relatively less affected and is substantially less affected when the correlation is executed between increases in Brent and in the ex-energy CPI.

And of course, all countries face more or less the same oil price situation with the minor exception that oil is priced in dollars so that exchange rates can modify the pressures experienced here and there.

The inflation chart at the top does draw some parallels with the cyclical impact of recessions on prices as well as with the role of oil which has pronounced cyclical properties as well.

Prices are responding in tight formation since the covid period emerged. That raises a question: does causation flow from oil to the PPI or from the business cycle to the PPI or from Covid and Covid policies that were engaged to the economies and then to the PPIs? What is the real agent of change here? It seems that it is Covid and that everything else is some form of collateral damage. And Covid is still active.

OPEC-plus has already cut a deal to try to support higher oil prices. While supply chain issues may be temporary there are also many global supply chain changes that are being made to reduce dependence on China (for example). In the U.S. with a new party in control, fiscal policy and the whole of the national wage structure is being pressured by new goals moving to a concept of fairness instead of one based on competitiveness and market pricing. How this purely domestic notion of fairness, as distinct form ability, will fit in with the notion of free trade and how U.S. workers will compete with lower paid workers overseas we have yet to discover…

Everywhere globally fiscal policy has been more expansive and debt levels are higher. Meanwhile, unemployment is still elevated since many firms have gone out of business. The lessons of the pandemic are affecting economic behavior in ways that it is difficult to predict and that may or may not have lasting impacts on the price level and economic performance.

In short, there is little reason to think that anyone or any central bank really knows what is in store for the future. The ECB has recently changed its policy focus to target an undefined average inflation rate of 2%. The Federal Reserve in the U.S. made that shift a year ago. These shifts give policy more flexibility, more discretion and probably allow for less oversight. In the case of the ECB, it is an actual easing of policy since inflation can be higher under the new policy than what would have been allowable before.

Currently central bankers are ignoring the flaring of inflation even though it is by far the worst in a decade and a period of historic inflation proportions as it stands. That could change. But with so many loose ends, is it a good time to assume that this inflation flare will go away? The chart shows that inflation is cyclical and that after flaring prices generally settle down but to what level or pace? That is the question. And this timeline is short. We have had other periods in which inflation settled into a steady but too-high of a pace. The final question is whether inflation of this magnitude will shift expectations. So far, it seems to be doing just that, but central banks are not attuned to this shift because they are still focused on nursing economic recovery ahead and in getting the unemployment rates back down to their pre-Covid levels. While that may be an aspirational, we have no idea if it is in fact a reasonable goal for the period immediately ahead.

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