Inflation and the USD Q&A

Posted by Neil Hume on Oct 28 16:48.
 
Q: How much does the USD need to fall to meaningfully boost US inflation?
A: A lot.
That’s the conclusion of a benchmarking exercise Goldman Sachs has run on dollar weakness and inflation and explains why Jan Hatzuis and his team believe the Fed needs to buy $2,000bn of assets under QE2 if it serious about hitting its inflation and unemployment targets. A couple of hundred billion here or there is just not going to cut it.
The report finds that:

• statistically, the pass-through from USD declines into US inflation has always been low, and appears to have fallen to near negligible levels in recent years.

• USD needs to fall a lot further – even after recent  declines – to contribute to raising inflation towards the Fed’s desired level.

• Ultimately, core inflation remains hostage to movements in components which are driven by domestic developments rather than external.

Historically, only a relatively small fraction of a Dollar fall is ‘passed through’ into consumer prices. For example, a paper by researchers at the Fed concludes based on data from 1981 to 2000 that a 10 percent decline in the trade-weighted Dollar boosts inflation by only around 30 bps, a very small effect. The small magnitude of this effect reflects a variety of factors, among which perhaps the most important is the desire of foreign exporters to preserve market share in the US, which means that they tend to react to Dollar falls by accepting smaller profit margins rather than hiking prices.

What all this points to is that – in line with the academic literature – the ‘pass-through’ from Dollar declines to US consumer price inflation is small. This in turn means that – if indeed the Fed sees the Dollar as one of its key policy levers for preventing inflation from staying below its mandate for a prolonged period – the Dollar needs to fall a lot further from here.

Ultimately, core CPI inflation remains hostage to the slowdown in rental (shelter) price and services (less shelter) price inflation – a point we have made repeatedly in our research and one of the main reasons why our bond forecasts have been below the forwards over the past 18-months. These components represent a significant component of the core inflation rate at approximately 31.9% and 28.3% respectively and are typically determined largely by domestic as opposed to external factors. And so as domestic conditions remain depressed, core inflation is likely to remain below levels the Fed would consider consistent with its mandate for some time.

Sadly Goldman doesn’t spell out what “a lot further from here” means. All we do know is that it’s Markets team are forecasting a further 5 per cent decline in the Dollar on a  broad, trade-weighted basis over the next 12 months.

ftalphaville.ft.com/blog

Focus on the real

Oct 26th 2010, 12:17 by R.A. | LONDON

HERE'S an interesting piece of analysis:

In nominal terms, the yuan has strengthened about 2.5% since China's June 19 decision to ease its currency policy. That works out to an annualized rate of nominal appreciation of almost 8%. The simplest way to calculate real appreciation is to add on the difference between China's inflation rate (3.5%, according to August data) and US inflation (about 1%, or even less if the dip in the September figures holds up). Doing so gives us an annual rate of real appreciation of more than 10%. Two or three years of that would pretty well eliminate the 20 to 40% undervaluation that critics are talking about.

As Tyler Cowen says, what you're really interested in is the inflation rate for tradable goods, but the point is still a good one. China's inflation rate (and, almost certainly, its rate of wage growth) is well above America's. That's just as important in determining export competitiveness as movements in the nominal exchange rate.

economist.com/blogs/freeexchange

2010, a Year of No Inflation

 September 13, 2010

By DAVID LEONHARDT

 

 

Bureau of Labor Statistics, via Haver Analytics Six-month change in the Consumer Price Index.

The lack of inflation this year is a story that deserves more attention than it has received.
On Friday, the Labor Department will release the inflation number for August. Economists are expecting an increase of about 0.2 to 0.3 percent over July’s Consumer Price Index. If that’s correct, it won’t be nearly enough to reverse a remarkable period in which prices have barely risen at all.
Over the last two years, inflation has been zero. Over the last year, it has been just 1.3 percent. Over the last six months, it has been below zero — negative 0.7 percent.
Since the Labor Department started keeping records in 1947, there have been only six six-month periods when prices have fallen more than that. All of them were in 1950, an unusual time when prices were falling even though the economy was growing.
This year’s price declines are clearly a reflection of the economy’s weakness. And yet the Federal Reserve has continued to
resist taking aggressive action to lift growth.
Remember, the Fed has a dual mission: keep inflation contained and maximize employment. By any measure, inflation is contained, and the economy is millions of job shy of maximum employment. Yet the Fed has taken only minor actions to lift growth and says it stands ready to take more action.
Why? The Fed — especially the regional Fed banks — is filled with economists and bankers who have strong memories of the 1970s and 1980s inflation. They’re always on guard against it.
There is no question that inflation can be terrible. Right now, though, it sure looks like the last war.

economix.blogs.nytimes.com