An Economist Looks at Inflation

[kevink]

The latest post from the always-worthwhile TIPS Watch site is an especially good one, IMHO. Well worth taking the time to watch the short video linked to within it.

Interesting to hear why comparisons of inflation today vs. decades ago are dubious at best. Actionable conclusions seem pretty obvious: plan for persistent high inflation for quite some time to come and invest accordingly.

https://tipswatch.com/2022/09/04/video-a-finance-professor-offers-common-sense-on-u-s-inflation/

 

[lawman]

invest accordingly.

https://tipswatch.com/2022/09/04/video-a-finance-professor-offers-common-sense-on-u-s-inflation/

That's the hard part..

 

[Montecfo]

It is interesting, but a bit misleading. Essentially he says if we have say 3pct inflation the last 6 months of the year, we should be unhappy because inflation which occurred earlier in the year has yet to hit the annual number, and will result in annual inflation above 8.5 pct for the year.

To me this is mathematically true but meaningfully false. The near-term trend says the most about the direction of prices, and we should care about that most.

Stated differently, for annual inflation to come down you need the monthly figures to moderate. If they do so that is very good news, despite higher readings earlier about which there is nothing to be done.

 

[JBTX]

It is interesting, but a bit misleading. Essentially he says if we have say 3pct inflation the last 6 months of the year, we should be unhappy because inflation which occurred earlier in the year has yet to hit the annual number, and will result in annual inflation above 8.5 pct for the year.

To me this is mathematically true but meaningfully false. The near-term trend says the most about the direction of prices, and we should care about that most.

Stated differently, for annual inflation to come down you need the monthly figures to moderate. If they do so that is very good news, despite higher readings earlier about which there is nothing to be done.

True, but reported numbers are what they are, and reported numbers are by definition going to be higher than people expect. Also, as pointed out, in housing there is a lag between when the inflation happens and when people feel the pain of the inflation.

Also, reported inflation numbers are the basis of social security inflation adjustments, ibonds, TIPS, etc so they are relevant. Also, understanding the mechanics shows that the fed will probably have to tighten longer than many expect.

With housing being 1/3 of the measure you get delayed and seemingly perverse effects. A smaller part of the housing cost inflation is actual rent inflation and will be delayed for the reasons explained by Harvey. A bigger part of the housing is owner equivalent rent which is based upon surveys of homeowners of what they think they could rent their house for. I have to think that is lagging, because how many people pay attention to what they can rent their house for? Also, as interest rates rise to fight inflation, mortgage rates and payments rise, which would likely increase perceptions of owners equivalent rent. So until rates stop rising, and for some period after, you will likely see increasing owners equivalent rents.

Given all that I have been puzzled how the 10 year projected inflation rate by comparing TIPS and conventional bonds has been something like 2.4%. It just seems like the market is not understanding how inflation works. Add to that all of the structural demographic and geopolitical issues that will likely push inflation higher for a while.

 

[Montecfo]

True, but reported numbers are what they are, and reported numbers are by definition going to be higher than people expect. Also, as pointed out, in housing there is a lag between when the inflation happens and when people feel the pain of the inflation.

Also, reported inflation numbers are the basis of social security inflation adjustments, ibonds, TIPS, etc so they are relevant. Also, understanding the mechanics shows that the fed will probably have to tighten longer than many expect.

With housing being 1/3 of the measure you get delayed and seemingly perverse effects. A smaller part of the housing cost inflation is actual rent inflation and will be delayed for the reasons explained by Harvey. A bigger part of the housing is owner equivalent rent which is based upon surveys of homeowners of what they think they could rent their house for. I have to think that is lagging, because how many people pay attention to what they can rent their house for? Also, as interest rates rise to fight inflation, mortgage rates and payments rise, which would likely increase perceptions of owners equivalent rent. So until rates stop rising, and for some period after, you will likely see increasing owners equivalent rents.

Given all that I have been puzzled how the 10 year projected inflation rate by comparing TIPS and conventional bonds has been something like 2.4%. It just seems like the market is not understanding how inflation works. Add to that all of the structural demographic and geopolitical issues that will likely push inflation higher for a while.

No disagreement that reported numbers are what they are. Reported number overstate inflation being experienced in the examples on the video, which was my point.

The reason the market expects 2.4 pct inflation is due to our projected population growth i.e., slow. Assuming the Fed does its work, and the government stops overspending, inflation should head toward that steady state rate.

Big If, I know. We have some new drivers of inflation: our energy policy and reshoring. So I do not expect it to be 1-2 percent as before.

 

[W2R]

The latest post from the always-worthwhile TIPS Watch site is an especially good one, IMHO. Well worth taking the time to watch the short video linked to within it.

Interesting to hear why comparisons of inflation today vs. decades ago are dubious at best. Actionable conclusions seem pretty obvious: plan for persistent high inflation for quite some time to come and invest accordingly.

https://tipswatch.com/2022/09/04/video-a-finance-professor-offers-common-sense-on-u-s-inflation/

The Tipswatch article is indeed interesting and makes some very good points. As retirees, we may find it easier to cope with inflation than those working for a fixed salary.

AFAIK those retirees who do not plan to move are not going to pay more for housing due to inflation, if they have a house that is paid off (like us), or a conventional 30 year mortgage, for example. The people who are renting or who need to move are the ones who I suppose could get really hit hard by inflated housing prices. Perhaps these are a little more likely to be working people instead of retirees.

I guess where Frank and I will see the greatest effects from inflation, might be from rising food and utilities costs (we don't use much gasoline). Hopefully the proposed gigantic social security cost of living increase could help, if it indeed materializes. After listening to the video, I am thinking it may not. Oh well! By now we all know how to tighten our belts and cut back, if need be.

 

[JBTX]

No disagreement that reported numbers are what they are. Reported number overstate inflation being experienced in the examples on the video, which was my point.

The reason the market expects 2.4 pct inflation is due to our projected population growth i.e., slow. Assuming the Fed does its work, and the government stops overspending, inflation should head toward that steady state rate.

Big If, I know. We have some new drivers of inflation: our energy policy and reshoring. So I do not expect it to be 1-2 percent as before.

I’m not sure lower population growth is in itself an inflation suppressant. Actually if you look at the US and worldwide the workforce relative to the population is shrinking as the world grows older and lives longer. You are seeing a tight labor market here. Europe and Japan have aging populations, and China is expecting to have decreasing population, and that will manifest in the labor market first. All these could contribute to a bit more labor inflation than we’ve had - for decades we had positive baby boom demographics, women entering the workforce, and expansion of global workforce. All of those things have now come to an end.

Of course, technology and automation are always going to keep a lid on overly high labor costs. And whether or not other emerging markets can pick up some slack remains to be seen.

As you mention, the move to renewable energy coupled with global energy growth should put some positive pressure on energy prices, at least during the transition. More hostile relationships with Russia and China could lead to more price instability. Climate issues could lead to food supply disruptions.

Of course the world often changes in ways we don’t expect so predicting the future is fraught with danger.

 

[daylatedollarshort]

It just seems like the market is not understanding how inflation works.

That does seem to be the case. We saw that in the beginning of the year when the Fed says they were going to raise interest rates 6 -7 times and the market didn't really react until maybe the second increase actually took place 2 - 3 months later.

Historically, interest rates have to go higher than inflation in order to bring inflation down. Otherwise, high inflation with lower interest rates discourages saving and encourages spending now before prices go up, which helps fuel further inflation. Maybe this time is will be different, but odds are it will be the same. Interest rates will have to go much higher than they are now to bring down inflation to a 2% rate. And it will likely take a recession to bring the unemployment rate up. Right now there are 2 jobs for every applicant. That has to have an upward pressure on wages.

I'm not as excited at the current corporate bond rates as some posters here (real interest rates of -3% to -4%) and have been only buying TIPS for maturities over a year.

 

[Montecfo]

I think the market reaction to announced plans by the Fed has nothing to do with misunderstanding inflation (and more importantly, rising rates). Rather, it has do do with Fed credibility. The market does not always believe Fed plans as communicated. This happened last fall, this summer, and will likely happen again soon.

The current selloff is due to the market believing the Fed may be serious about raising rates hawkishly.

But when Fed rhetoric softens, there is lots of money on the sidelines waiting to buy as we saw this summer.

I expect this may continue.

 

[Montecfo]

I’m not sure lower population growth is in itself an inflation suppressant.

Nor was that my point. But a slowly growing economy would be expected to generate price stability absent expansionist monetary policy or large fiscal deficits, which was my point.

Plenty of historical examples back this up.

 

[ncbill]

The Tipswatch article is indeed interesting and makes some very good points. As retirees, we may find it easier to cope with inflation than those working for a fixed salary.

AFAIK those retirees who do not plan to move are not going to pay more for housing due to inflation, if they have a house that is paid off (like us), or a conventional 30 year mortgage, for example. The people who are renting or who need to move are the ones who I suppose could get really hit hard by inflated housing prices. Perhaps these are a little more likely to be working people instead of retirees.

I guess where Frank and I will see the greatest effects from inflation, might be from rising food and utilities costs (we don't use much gasoline). Hopefully the proposed gigantic social security cost of living increase could help, if it indeed materializes. After listening to the video, I am thinking it may not. Oh well! By now we all know how to tighten our belts and cut back, if need be.

Well, don't forget property taxes...in most of the USA (like here) increases are not limited.

What was eye-opening for me was checking on the old house where I grew up.

Mom sold it in the late 80s...last sale was for triple the price she sold it, roughly keeping up with the rate of inflation.

Over that same period of time annual property tax went from ~$3,000 to ~$18,000...a SIXFOLD increase.

Even though our property tax rate is relatively low versus the rest of the country.

 

[Chuckanut]

One of the biggest sources of inflation for me is state and local taxes.

Gasoline taxes will increase by at least 20 cents next year due to a new carbon tax. The carbon tax will also drive price increases in many areas of life. Over 60% of car tabs are for a new transit system. Also higher tabs because I drive a hybrid. My property tax will rise at least 5%. Assorted state fees have risen. And a new income tax on capital gains is about to start. That’s just what I can think of at the moment.

I

 

[Teacher Terry]

Our property taxes are capped at 3% a year if owner occupied. Since they are only 400/year it’s not a concern. My biggest expense has been HI since going on Medicare. Definitely not cheap. I have cut every discretionary expense except I keep 100 for going out with friends and other social events. Luckily my pension has a COLA. I am determined to live on my income and keep my savings for emergencies. It was much easier to do 2 years ago.

 

[marko]

Our property taxes are capped at 3% a year if owner occupied. Since they are only 400/year.

Gee. My property taxes are only $288..................a week!!

 

[lawman]

Our property taxes are capped at 3% a year if owner occupied. Since they are only 400/year.

Gee. My property taxes are only $288..................a week!!

I live in Texas and here one never owns his home regardless on whether it's paid for or not..

 

[aja8888]

I live in Texas and here one never owns his home regardless on whether it's paid for or not..

The deed is in your name so you are the owner (I'm in Texas too). However, and like everywhere else, if you don't pay your property tax, the county can put a lien on the property.

 

[Bamaman]

I lived through the years of high inflation and ultra high interest rates during the Jimmy Carter VooDoo economics. Life was extremely difficult being in the car business during those times.

And the thoughts of long term inflation scares me to death. It's one thing if you have a $25,000 IRA balance. But to those of us with multi million dollar IRA/401K accounts, inflation is a big thing--and extremely real.

 

[MichaelB]

Multiple posts with broken quotes were edited.

Voodoo economics was a term that President Bush used when describing economic policies of Pres Reagan. Inflation took off in the US during Pres. Ford’s term and continued during the following term of Pres Carter. In both cases it is unlikely to have any partisan cause. Petroleum price increases combined with poor monetary policy (non-partisan Fed, not elected gov’t) were the drivers.

 

[braumeister]

I never really understood why these things didn't work.

 

[daylatedollarshort]

I'm fine with inflation. We planned for it and come out ahead in periods of high inflation. The problem is negative real interest rates. If I was making 10% on fixed income besides TIPS, I'd be a lot happier. But 3% Treasuries with 12% real inflation, per the video, that is not great.

 

[MichaelB]

I never really understood why these things didn't work.

Yes, a slogan without a policy doesn’t stand much of a chance.

Alan Greenspan was Chair of the Council of Economic Advisors when that came out. In one of his books he wrote that when it was announced out his reaction was “ This is unbelievably stupid”.

 

[Gearhead Jim]

I'm fine with inflation. We planned for it and come out ahead in periods of high inflation. The problem is negative real interest rates. If I was making 10% on fixed income besides TIPS, I'd be a lot happier. But 3% Treasuries with 12% real inflation, per the video, that is not great.

Details please, on how you will "come out ahead in periods of high inflation."
There are some investments that might outpace inflation, but maybe they won't.
Getting a good blip is one thing, consistently exceeding inflation is much tougher. Please tell us the plan.

 

[daylatedollarshort]

Details please, on how you will "come out ahead in periods of high inflation."
There are some investments that might outpace inflation, but maybe they won't.
Getting a good blip is one thing, consistently exceeding inflation is much tougher. Please tell us the plan.

My inflation adjusted income (SS and TIPS income, with real returns greater than CPI inflation) is much greater than annual expenses subject to inflation. We use a matching strategy - https://www.bogleheads.org/wiki/Matching_strategy.

 

[Gearhead Jim]

SS and TIPS are supposed to match inflation, and then you usually pay taxes on your gains. That's quite different from simply having enough money that inflation is not a problem for you, or using certain investment to cover your "must have" expenses and using riskier investments for you "fun" expsnses.

I still don't see how any of the strategies listed in the boggleheads link will allow you consistently to come out ahead of inflation, after taxes. Their merit seems to be in preventing going broke, a good idea but not the same thing.

 

[youbet]

^^^^^

+1