Friday, April 29, 2011

5 Reasons Inflation Will Keep Rising

Douglas Porter, deputy chief economist at BMO Capital Markets, wrote a report on why inflation will keep rising. He says that in recent announcements, both the Bank of Canada and the Federal Reserve sounded in absolute zero rush to begin tightening policy, with both viewing the recent rise in headline inflation as transitory, "Yet, there is a clear danger that policy-makers risk suddenly falling behind the inflation curve."

1. "Core inflation is contained"

But we all know how much the prices we pay have rise, in spite of this argument for "core inflation". Mr. Porter says that this argument holds that inflationary pressures are limited to food and energy prices. However, the recent upswing in headline inflation - or real inflation, which include the things we both need and buy, consumer goods, is not limited to the most volatile items. Core inflation strips out energy and food prices (as if we did not need these) is also on the rise.

Second, for more than a decade there has been a growing gap between core and headline numbers, which reduces the usefulness of the core consumer price index as a gauge of underlying inflation.
Annual percentage change as of March 2011
  • Fuel oil +31.3%
  • Gasoline +18.9%
  • Fresh vegetables +18.6%
  • Airfares +12.3%
  • Coffee +9.9%
  • Sugar +8.3%
  • Parking +8.2%
  • Postal services +8.0%
  • Cable and satellite +7.1%
  • Water +6.3%
  • Cigarettes +5.7%
  • Bread +5.0%
  • Meat +5.0%
  • Home insurance +4.9%
  • Auto insurance +4.7%
  • Electricity +4.3%
  • Child care +4.2%
  • Tuition +3.8%
  • Books -4.4%
  • Home entertainment equipment -4.1%
  • Recreational equipment -3.2%
  • Fresh fruit -3.1%
  • Mortgage interest -2.2%
  • Natural gas -2.0%
  • Rice -2.0%
  • Detergent -1.9%
  • Household textiles -1.8%
  • Footwear -0.9%
  • Alcohol at stores -0.8%
  • Appliances -0.6%
  • Seafood -0.2%
  • Clothing +0.1%
  • New vehicles +0.2%
  • Telephone services +0.4%
  • Prescription drugs +0.8%
  • Rent +1.2%
2. A huge output gap will keep prices in check.

The argument is that the high unemployment rate in the U.S. will keep wage gains and prices low.

"Yet this slack could be less effective in controlling inflation, as much of the spare industrial capacity may be obsolete and it will take years to retrain the jobless, suggesting the natural rate of unemployment has at least temporarily risen".

The output-gap argument hardly applies for Canada, where it is already shrinking quickly and the jobless rate is below its long-term average.

3. Coming restraint will keep a lid on growth and thus inflation.

While government restraint (if it indeed happens and the printing presses stop - don't count on it) will certainly contain growth. But that restraint could also simply result in higher user fees, regulated price increases and sales tax hikes as governments work back recession-era deficits.

Mr. Porter quotes Statistics Canada as saying sales tax increases alone have accounted for 0.9 percentage points of the 3.3 per cent rise in consumer prices over the past year.

4. Wages remain restrained and are likely to remain so, as labour is weakened.

Bernanke just said so... Mr. Porter says that this is the central bankers' strongest argument. But he is quick to point out that the Phillips Curve, which shows that the lower the unemployment rate the higher the rate of inflation, is alive and well, and that the recent dip in the jobless rate in Canada and the U.S. suggests the low point for wages has passed.

Further to the notion that the U.S. natural unemployment rate has shifted higher, there is already anecdotal evidence -even in the U.S. -of labour shortages in skilled trades.

5. Intense competition, especially from China, will halt inflation.

This is a good argument, but it is becoming less significant as many Asian countries also grapple with rising inflation and gradually pass these cost increases on to other nations. Moreover, China and other emerging markets are allowing their currencies to rise, driving up the cost of imported goods.

In the U.S., this effect is compounded by the fall in the dollar.

With news from Ottawa Citizen

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