Some issues just keep returning like a boomerang and the idea that higher inflation is good for us is something that makes me think of these lines from Hotel California by The Eagles.
They stab it with their steely knives,
But they just can’t kill the beast.
This is an issue that the Ivory Towers return to again and again in spite of the fact that the evidence is the other way. Let me show you what has triggered the revival of this particular beast. From Eurostat yesterday.
Euro area annual inflation is expected to be 1.2% in May 2019, down from 1.7% in April according to a flash
estimate from Eurostat, the statistical office of the European Union.
Looking at the main components of euro area inflation, energy is expected to have the highest annual rate in May
(3.8%, compared with 5.3% in April), followed by food, alcohol & tobacco (1.6%, compared with 1.5% in April),
services (1.1%, compared with 1.9% in April) and non-energy industrial goods (0.3%, compared with 0.2% in April).
I have give you the full breakdown because as you note that inflation such as it is finds itself driven by energy and food prices. So the core measures so beloved of central bankers will be even lower than the headline. You can take your pick from the choices but if you exclude energy core inflation falls to 1% and the food category ( along with alcohol and tobacco) it falls even more to 0.8%.
This is perceived to be a failure as inflation nutters look back to a headline inflation level of 2% last May. In terms of the ECB ( European Central Bank) target last May was bang on although if one indulges in some numerical pedantry we know that former President Jean-Claude Trichet defined the target as being 1.97%.
So we have fallen below it and the picture on the core measures is lower than that. Hence the argument that something needs to be done. This is added to by inflation expectations and here people like to concentrate on the 5year, 5year swap which this morning has fallen to 1.26% according to Bloomberg as opposed to the 1.8% that 2018 opened with. So if you believe it we will see lower inflation for the next five years.
Before I move on I would just like to be clear that I have little or no faith in that swaps contract as being reliable. Just like in other forwards markets it tells you what we know and think now which is not a reliable indicator of the future. Putting it another way Frederik Ducrozet has broken it down.
His breakdown, which is based on models used in a 2017 ECB working paper, show that actual inflation expectations have made up over 30% of the drop in the forwards pricing this year, up from less than 15% in the past year. ( from
As you can see even fans of the measure only think 30% of it is relevant
The Problem of a 2% Inflation Target
It is time for my regular reminder that the 2% inflation target was pulled out of thin air. Or to be more specific it was chosen because it “seemed reasonable” by the Reserve Bank of New Zealand. On that basis the 1.2% of the Euro area can also seem reasonable. Personally I would prefer it but I will come to that later.
Higher Inflation Targets
The Ivory Towers have regularly pressed for this as we step back in time to June 2014 and look at a working paper from the IMF.
This essay argues that a two percent inflation target is too low. It is not clear what target is ideal,
but four percent is a reasonable guess, in part because the United States has lived comfortably with
that inflation rate in the past.
Most of those would lived through such periods would not agree with that but remember it is a long way down to the reality of earth when your Ivory Tower is in the clouds. More recently Adam Posen of the Peterson Institute suggested this for the ECB.
committing itself to forms of fiscal quantitative easing, and working with other central banks to raise inflation targets above 2 percent.
As you can see we are being taken to extreme levels of central planning here. Back when he was at the Bank of England Adam Posen supported ever more extreme monetary measures but we never get an answer to the question why we always need more? Also of course he left the Bank of England due to this.
‘They should have somebody who gets it right and not me. I am accountable for my performance.’
You may not be surprised to read that he got inflation wrong after expecting a decline and getting an overshoot.
The Ordinary Person
If we look at a breakdown of inflation in 2018 from Eurostat the ordinary person might be convinced inflation is already at the levels the Ivory Towers want.
On average, household electricity prices in the European Union (EU) increased to €21.1 per 100 kWh (+3.5%),
between the second half of 2017 and the second half of 2018………Household gas prices increased by 5.7% on average in the EU between the second semester of 2017 and 2018 to €6.7 per 100 kWh.
Also the Ivory Towers look at inflation numbers and make a clear error which is not to acknowledge the fact that we require housing. The Euro area numbers only account for those who rent and not those who own so let me help out a bit.
House prices, as measured by the House Price Index, rose by 4.2% in both the euro area and the EU in the fourth
quarter of 2018 compared with the same quarter of the previous year. These figures come from Eurostat, the
statistical office of the European Union.
Compared with the third quarter of 2018, house prices rose by 0.7% in the euro area and by 0.6% in the EU in the
fourth quarter of 2018.
We do not know the more up to date numbers but if we take the broad sweep they would be an upwards influence if they were counted in the official measure as they were supposed to be. I will not tire you with the details here as it is an area of expertise for me and to cover it fully is worthy of an article on its own. But the summary is that after years of what the apocryphal civil servant Sir Humphrey would call “fruitful work” we have arrived back at the beginning or if you prefer it in musical terms.
We’re on a road to nowhere
Come on inside
Takin’ that ride to nowhere
We’ll take that ride ( Talking Heads)
Thus our Ivory Towers with their core measures make a pretty clean sweep of missing the areas which are most vital as we note they include food,energy and shelter.
There are two essential problems with the arguments above. The opening one is the changed behaviour of wages. Pre credit crunch we had the so-called NICE period where wages growth generally exceeded inflation. It changed things and the pattern now is that the relationship was broken as we have seen periods where real wages have fallen. In my country the UK the sharpest real wages fall came when Adam Posen got the sort of thing he wanted as inflation went above 5% but wage growth did not respond. Putting it another way we got a real wage boost when inflation fell in the period 2015/16 which was exactly the reverse of the somewhat hysterical headlines from that period suggested. Also since my post of the 29th of January 2015 I have regularly pointed out that lower inflation has clearly been a boost for retail sales across a wide range of countries.
Next comes an issue which I will highlight with a simple question. Why do we always need more stimulus? The proponents of them never answer this. The issue that we may make marginal temporary gains but face permanent losses gets marginalised and pushed aside.
Also the stimulus has quite often failed in generating either inflation or growth. The place that has tried pretty much everything is Japan and here is Governor Kuroda from the end of last month.
Bank of Japan Governor Haruhiko Kuroda said major central banks may have to become more flexible targeting inflation, as they are missing targets due to the price dampening effects of technological innovations and globalisation.
He is getting so desperate he now needs to present “technological innovations ” as a bad thing. I bet he will not be getting rid of his smartphone.