For all the talking heads’ bloviating about the massive inflation to come from current Fed policies and the spending stimulus, as well as the media’s eagerness to pronounce the recession over, you can be forgiven for not noticing that deflation has not exactly gone away.  The Bureau of Labor Statistics announced yesterday that over the past 12 months wholesale prices dropped 5 percent and today that over the same span consumer prices dropped 1.3%; the respective declines were the largest since 1949 and 1950.

I said a few months ago that I was not particularly worried about deflation, and I’m still not, as it seems mild by historical standards and because expansionary Fed policies are making sure that money-stock growth is strong.  But an awful lot of people have assumed away the recession and are now wringing their hands about the threat of inflation, and these data suggest both impulses are premature.*

Two big caveats and one big anti-caveat to these data:

  1. As “compared to 12 months ago” (or y/y, for “year over year”) data, they will be influenced by observations that are several months old and may no longer represent where the economy is.  A close look at the monthly data suggests this is the case.  Wholesale prices declined in the last three months of 2008, as well as this March.  Since then, they’ve risen modestly.  The y/y decline is so large now mainly because the modest price gains to the past two months replace relatively large price increases in April-May 2008.  (By that token, the y/y decrease from June 2008 to June 2009 will likely break this month’s record, as June 2008 also saw a big increase in wholesale prices.)
  2. Once again, these data are largely driven by ever-volatile energy prices.  The “core” producer (wholesale) price index (PPI), which excludes energy and food prices, didn’t change all that much (0.2% per less) in any of the past five months, and it actually rose slightly in all of the past 13 months except the last one, when it fell 0.1%.  The core PPI increased by about 3% over the past 12 months, about the historical norm.  And the core consumer price index (CPI) rose by 1.8% over the past 12 months.
  3. Now for the big anti-caveat:  Rents.  The consumer price index (CPI), just like U.S. GDP figures, includes “owners’ equivalent rent of primary residence,” i.e., imputed rents on owner-occupied housing.  Just as renter pays a monthly price on her apartment, a homeowner implicitly pays a price on her home, as the opportunity cost of not renting it out.  Now, if what I just read here on Calculated Risk and Mike Shedlock’s (Mish’s) Global Economic Trend Analysis, is correct, the CPI imputed-rent figures are calculated simply by asking a sample of homeowners what they think their houses would rent for.  This is likely to be extremely unreliable, since most homeowners who aren’t landlords (e.g., me) may tend not to keep tabs on changes in market rents.  Mish says that if you replace the owner-guesstimated rent numbers in the CPI with data from the respected Case-Shiller housing index, you get y/y declines of 5% for each of the last three months.  (Now, that could be overstated, as rents tend to fluctuate a lot less than housing prices — which is how some people detected the housing bubble — but it seems plausible that those imputed rents have not gone down as much as they should have.  And imputed rents are 24% of the CPI, so there could be a big distortion here.)

* On the long-term inflation threat:  I recognize that the Fed will have a major policy challenge on its hands when economic conditions improve and banks want to lend out the staggering amount of excess reserves ($877 billion, up from $2 billion a year ago) they have handy.  The Fed faced exactly the same problem in 1936-37, after three years of rapid (but far from full) recovery from the depth of the Great Depression.  Back then they made the wrong choice, doubling bank reserve requirements and plunging the economy into an even sharper contraction than in 1929-33.  The right choice is clearly somewhere in between doing that and letting the banks loan out all that money and generate a big inflation.  How the Fed threads the needle will be something to watch.

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