Whilst considering the position of inflation linked securities in the United States and their recent performance a thought occurred to me about the differing views on the subject of inflation of the heads of two of the worlds main central banks. These are Ben Bernanke of the US Federal Reserve and Mr. Trichet of the European Central Bank. My contention is that the inflation performance of the two underlying countries/regions is much more similar than you might think from reading the mainstream media. I wrote on this subject on the 2nd of July when I discussed the inflation indices used in the United States and pointed out that the Bureau of Labor Statistics in the US does calculate an inflation index on the same basis as the Consumer Price Index used in both the UK and Europe. This is called the HICP or Harmonised Index of Consumer Prices.
At the latest Press Conference for explaining the policy decisions of the European Central Bank Mr. Trichet expressed satisfaction that the latest figure for Consumer Price Inflation was 1.9% in the Euro zone and he went on to say that not only was this on target but he expected this situation to continue. In his answers to questions he went further.
Well, there are German citizens in this room. They can say that the euro has given the 330 million citizens of the euro area, including their compatriots, price stability, with inflation standing at 1.97%. Nobody ever challenges this when I say it. In Germany, the figure is even better. For Germany, inflation has stood at around 1.5% since the inception of the euro, the best result for Germany and indeed the euro area as a whole in 50 years. Frankly, for an institution that was called on by the citizens of Europe to have a primary mandate of delivering price stability, I think this is worth repeating.
Although the ECB website does not make this entirely clear he was referring to the inflation performance in the Euro zone since the inception of the ECB as well as current figures. There is of course a danger of hubris in concentrating on slapping oneself on the back about inflation performance at a time when some of the consequences of the decisions which helped to achieve it have caused such financial distress in some of the peripheral Euro zone countries. However UK citizens would be much happier if their central bank was capable of hitting its inflation target in the way that the ECB has and over not dissimilar time periods the ECB’s inflation performance stands out in recent years as being far superior. However my main point today is to say that the head of the ECB is very happy with an inflation rate of 1.9% and an average over the ECB’s life of 1.97%. As an aside it is quite refreshing to have a central banker concentrating on the day job!
The American position on inflation: Ben Bernanke and the Federal Reserve
Rather than being happy with the inflation performance in the United States Ben Bernanke has expressed himself to be unhappy with it. He wishes to raise the level of inflation in the US economy as measured by its own Consumer Price Index. I discussed what I consider to be the main flaws in this index back on the 2nd of July in my article on it. At this time it is rising at 1.2% on an annual basis and Mr. Bernanke has embarked on a policy to try to raise it to more like 2%. He and the other members of the Federal Reserve have committed themselves to spending an extra US $600 billion on asset purchases (of US government debt/bonds) to try to help this happen. They have also discussed more aggressive policies such as attempting to catch up on the period where US inflation on this measure has been below 2% which would involve a boost of around 8% to the overall level of CPI.
Measuring US inflation the European way
If we do this we come up with some surprising results. The latest figure calculated by the Bureau of Labor Statistics is for October and it was for an annual increase of 1.8%. So not only is this very near to the target but it is also very close to the figure that Mr. Trichet at the European Central Bank considers to be such a success he crows about it. This gives us a somewhat different inflation picture to the one painted by Ben Bernanke but let me give you the figures for the rest of 2010 to ram the point home. In the first quarter 3.6%, in the second quarter 2.8% and in the third 2%. It seems even less like a number that needs to be boosted now.
As you can see from the figures I have quoted above measuring US inflation the European way gives a very different picture of the situation. It also puts a very different emphasis of the expansionary programme of asset purchases that he has embarked upon as on this measure they cannot be for the purpose of raising inflation to its target as it has been above it for most of the year and is now only just below it. We also see a most extraordinary divergence in policy between the US and the Euro zone from what are currently similar figures and in fact in 2010 have shown a higher performance in the US! They cannot both be right.
I also wish to point out that in my experience the HICP or European measure of CPI has led to an under measuring of inflation in the UK since it was introduced in the UK. It has been persistently below the previous measure called Retail Price Inflation and as I type this it is running at 1.4%. I will leave you to draw your own implications as to the possibility of this being also true in the US and the link to the Federal Reserve’s policy.
There is an American economist John Williams who calculates his own inflation indices based on the way that the United States used to calculate inflation before changes were made to it ( mostly in the Greenspan era). On his measure US inflation is in fact over 8%. Should he be right then Ben Bernanke is embarking on a very dangerous experiment, as a policy to raise inflation above 8% looks potentially suicidal. I will be interested in American readers thoughts on what the level of inflation is in their experience.
UK Producer Prices: more problems at the Office for National Statistics
Here is todays report from the Office of National Statistics.
Output price ‘factory gate’ annual inflation for all manufactured products rose 3.9 per cent in November. Month on month the output prices measure for all manufactured products rose 0.3 per cent between October and November, mainly reflecting price rises in petroleum products, food products, and computer, electrical and optical products.
But we also got.
Quality assurance by ONS revealed potential errors in some input prices in the Producer Prices dataset.
This is at best very embarrassing for the Office of National Statistics. It was only last month we found it making methodological changes to its calculations of these numbers and now suddenly it has such problems it cannot publish part of them. To use their own words “Figures for PPI this month are the first based on Standard Industrial Classification 2007”. There was an obvious problem immediately as I highlighted on the 19th of November in that this new classification has led to a reduction in the recorded numbers. Having looked back at them my estimate of producer price output inflation for November on the old basis is 4.5% or some 0.6% higher than the new measure. I will leave you to your own thoughts as to why and how this has happened. Throughout 2010 producer price inflation has proved to be a persistent problem on both its measures in the UK and has been a signal for problems with consumer inflation, in spite of the efforts of the ONS to use methodology to change this, it looks as though we have a continuing problem.
I try to be nice to the Office of National Statistics as I feel that in many respects it has a difficult job as it tries to do it as best it can. But as time goes by it is having ever more problems both with the way it presents numbers and the way its methodology changes which always seem to act in the same direction. Much more of this and it is in danger of being regarded as something with very little credibility at all and it does nothing for confidence in the UK economy.
UK Trade Statistics
Regular readers will be aware that in my experience trade statistics are perhaps the set of figures which are most volatile and unreliable over time. They are often heavily revised and the revisions which can happen some years later can completely change the message sent by them. For example many years after the event of the devaluation of the pound in the UK in 1967 it was discovered that the trade figures were in fact much better than the ones which led to the devaluation and accordingly that it may not have been necessary!
Accordingly I place very little weight on monthly trade statistics. However if you look at the UK’s overall performance since 2007 and then consider the depreciation of around 25% that took place in the early part of the period then you would hope, I think, for our trade performance to be better than it is now. The recent improvement in the UK economy with stronger growth figures appears to be leading to a rather familiar achilles heel of a rise in imports. Let us hope that the recent suggestions of an improvement in UK manufacturing will help with our export performance. Although on a conceptual level I am left with the troubling thought that at this time almost everyone is trying to export more and that unless we find some extraterrestrial trading partners it is a zero sum game, for every winner there is a loser.
Across the other side of the world China has produced a strong set of trade figures. Now their figures are unlikely to be any more reliable than ours but again we appear to be returning to known trends. And in a linking of the components of todays article it is leading to more inflationary fears in China as we await her latest inflation figures which are due tomorrow and I am aware that this means they will be released on a Saturday.
The Deflation/Inflation Conundrum
In recent times economics has polarised itself in something of a deflation/inflation debate. My contention here is that there are inflationary forces at play in the world and if you use the methodology of the European Central Bank, the United States with the asset purchases of its central bank and its latest fiscal stimulus from its government is taking something of a risk with it. Should Mr. Williams be right with his figures for US inflation then the policy moves start to look outright reckless.
In my view that does not mean that there are not deflationary influences too at work. For example there is plainly evidence of deleveraging in many of the worlds banking systems and problems in several parts of the Euro zone. Accordingly going forwards I expect the world to suffer from both and feel that the polarised world of economic textbooks and theoretical economics will be a very poor guide to what is likely to happen next and to imply that there is a choice between deflation and inflation is only one of many alternatives facing us and too much time has been spent on it already.