CPI indicates that inflation is tame; why no inflation?

Overall CPI prices rose 0.3% in August, in line with forecasts, and the year-over-year headline CPI inflation rate slipped to 1.1% from 1.2%. Energy prices rose 2.3% in August, while food prices edged 0.2% higher.

Core CPI prices were lower than expectations, remaining unchanged in August. The year-over-year core CPI inflation rate was unchanged at 0.9% (the fifth straight month at this rate).


Inflation in recent months has been very well behaved with core and overall inflation showing price stability (although inflation is a bit low for the Fed, who would prefer an inflation rate closer to 2%). Despite the flat core reading in August, there is no evidence in these data that we are headed towards deflation (the three-month inflation rates are marginally ahead of their 12-month counterparts, for example). However, over the next two years a big test of inflation theories is coming. Phillips-Curve or output-gap inflation theories predict deflation given the degree of slack in the economy.  A monetarist/Wicksellian perspective points to a significant rise in inflation (in indicators such as the price of gold).  An Austrian perspective would predict inflation with the huge amount of quantitative easing.

Anyway, our own research indicates some inflation takes time to appear after M2 growth.  We showed a 2 year gap from the inception of M2 growth until inflation begins.  We are about at 2 years, so I assume that in the next year something will happen.

Some countries, such as India, are well down the road to monetary tightening because of inflation (India hiked again yesterday, taking the policy rate to 6%). Food is likely to be a troubling area of the CPI over the next year. However, the Fed will have no inflation concerns and the majority of the FOMC are likely to be concerned about the potential for deflation. Although the price data do not stand in the way of further QE next week, we think it is unlikely that the Fed will take further action at the meeting (particularly since the August data on activity have had a firmer tone than the last few months).


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