Wednesday, January 01, 2014

Question #4 for 2014: Will too much inflation be a concern in 2014?

by Bill McBride on 1/01/2014 01:49:00 PM

Earlier I posted some questions for next year: Ten Economic Questions for 2014. I'll try to add some thoughts, and maybe some predictions for each question.

Here is a review of the Ten Economic Questions for 2013.

4) Inflation: The Fed has made it clear they will tolerate a little more inflation, but currently the inflation rate is running well below the Fed's 2% target. Will the inflation rate rise in 2014? Will too much inflation be a concern in 2014?

Although there are different measure for inflation (including some private measures) they all show that inflation is at or below the Fed's 2% inflation target.

Note: I agree with the FOMC view, that "inflation persistently below its 2 percent objective could pose risks to economic performance".   Some people think there should be zero inflation, I think this is incorrect and there are clear reasons that a little inflation is good for the economy.

I follow several measures of inflation, median CPI and trimmed-mean CPI from the Cleveland Fed.  Core PCE prices (monthly from the BEA) and core CPI (from the BLS).

Inflation Measures Click on graph for larger image.

This graph shows the year-over-year change for these four key measures of inflation through November. On a year-over-year basis, the median CPI rose 2.0%, the trimmed-mean CPI rose 1.6%, the CPI rose 1.2%, and the CPI less food and energy rose 1.7%. Core PCE is for October and increased just 1.1% year-over-year.

On a monthly basis, median CPI was at 2.2% annualized, trimmed-mean CPI was at 1.2% annualized, and core CPI increased 1.9% annualized.

For some technical reasons, core PCE has been lower than the other measures.  Goldman Sachs chief economist Jan Hatzius addressed this recently:

"almost half of the slowdown in core PCE inflation in 2013 was due to the slowdown in healthcare cost growth. Although a significant part of this slowdown is likely to persist, some of it—specifically the Medicare reimbursement cut related to the federal sequester—is likely to reverse in 2014 and this will likely add 0.1-0.2 percentage points to core PCE inflation."
So core PCE will probably move up a little year-over-year, but with all the slack still in the system (and little wage growth), I expect the other measures of inflation to stay at or below the Fed's target in 2014.  If the unemployment rate continues to decline - and wage growth picks up - maybe inflation will be an issue in 2015 or 2016.

So currently I think inflation (year-over-year) will increase a little in 2014 as growth picks up, but too much inflation will not be a concern in 2014.

Here are the ten questions for 2014 and a few predictions:
Question #1 for 2014: How much will the economy grow in 2014?
Question #2 for 2014: How many payroll jobs will be added in 2014?
Question #3 for 2014: What will the unemployment rate be in December 2014?
Question #4 for 2014: Will too much inflation be a concern in 2014?
Question #5 for 2014: Monetary Policy: Will the Fed end QE3 in 2014?
Question #6 for 2014: How much will Residential Investment increase?
Question #7 for 2014: What will happen with house prices in 2014?
Question #8 for 2014: Housing Credit: Will we see easier mortgage lending in 2014?
Question #9 for 2014: How much will housing inventory increase in 2014?
Question #10 for 2014: Downside Risks