Deflation? We're Not There Yet

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. We got fresh inflation data this week, and I am here with Bob Johnson--our director of economic analysis--for his take. Bob, thanks for joining me.

Bob Johnson: Great to be here today.

Glaser: Let's start with the big picture of why anyone should care about inflation beyond just thinking about what their grocery bill is going to look like or what their other spending is going to look like. Why is this an important metric?

Johnson: The main reason I look at [inflation] is because it's a recovery killer. Every time we've gotten to 4% year-over-year inflation, we've gone into a recession. There might have been other root causes to the problem; but every time we get to 4% inflation, we tend to go into a recession, which is why I really watch this metric very closely.

And at one point this spring in May, we got to monthly--and I emphasize monthly--inflation of four tenths of a percent. So, if you multiply it by 12, you are at about 4.8% annualized inflation, which kind of gets you over the mark. And so we had our worry signs up, and a lot of it was driven [by the weather]. We had a confluence of cold winter, which pushed up energy prices, killed off some fruits and vegetables, and really drove up food prices.

So, we had a confluence of bad things all in a couple of months. And there was some fear that that would continue, and we really did see it put pressure on the consumer. We saw them spending less. So thankfully, today's number was a little bit more merciful.

Glaser: What was that number?

Johnson: We actually saw a decline in overall prices, which is unusual. We haven’t seen it yet this year. We were down two tenths of a percent for a single month. And then on a single month year-over-year, we were at about 1.7% inflation, which is still running below that target.

Glaser: But if we saw that decline, do we now have to pivot from worrying about too much inflation to too little? Or are we in a situation, like Europe, where deflation is potentially a concern?

Johnson: Deflation is always a potential concern because deflation is something that’s very hard to get out of. And that’s why it's such a scare word with economists because we are so used to seeing a virtuous cycle where people buy more things and so you need more people to make those things. That creates more income, more spending. But unfortunately when you have deflation, it goes the other way; people say, "Why should I buy that car today? It's going to be $500 cheaper the following month. I'm just going to wait." And so, then you need less production and that means fewer employees and less income, and you get to this terrible, vicious cycle with prices going down and continuing to go down.

And it seems almost unstoppable, and that’s really what happened during the depression. So, that’s why deflation is important, but I don’t think we are there yet. At 1.7% year-over-year, I think we're still okay. I think there are still a large number of categories, on a year-over-year basis anyway, that are still up--even though there wasn’t much up in this particular month. Europe probably has a little more to worry about with deflation. I do think that there have actually been a couple of countries that have been in deflation for a couple of months over there.

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Glaser: Let's take a closer look at this report. You mentioned that not a lot of categories were up. What was the biggest driver of the decline?

Johnson: The biggest, by far, was energy overall and gasoline in particular. The whole energy complex tends to move this number up and down a lot. And we've gone through periods this year where gasoline's been down but maybe utilities have been way up--your natural gas, your electricity. This time, really, quite a bit of the energy complex was down, and the only one that was really up was electricity, which was up one tenth of 1%--a tiny increase. But really driving the headline number down a couple of tenths [of a percent] was the energy situation. But even if you take that out of there, we were relatively flat--which is very unusual--with a lot of categories down and not too many up.

Glaser: What were some of the other categories that had softness?

Johnson: I think airline tickets were down in price; we had a couple of bad months with that, and now we've had two months in a row where airline prices have been down again. So, that's good news for those who want to fly.

Certainly, used cars is another area that's been down in price, and it's been down because there have been so many new cars sold. And now there's a flood of used cars on the market, so that has really helped. And that helps the low-end consumer, sometimes, who is trying to buy a used car.

Even clothing was down a couple of tenths of a percent; apparel prices are basically flat for the year. Even medical was down a little bit again; it had shown some resurgence this spring, but medical prices were down again, which is really a big surprise.

Glaser: You mentioned to me earlier that it's a good month to be a vegetarian. What's happening with food inflation? That is obviously an area that's very visible.

Johnson: It is. Food inflation, overall, was up two tenths of a percent, making it one of the biggest gainers this month. It's hard to say that with such a small number it's the biggest gainer, but it is. As you mentioned, though, it's not all good news. Fruits and vegetables were down; the other category was down. But there were some other categories that were up. As I said, if you were a vegetarian, you were fine--fruits and vegetables were down. But beef, on the other hand, was up 1.5%. A lot of the other meat and protein-oriented products were up as well. In fact, beef is now up something like 8%--almost 9%--year over year. So, that's something that's very visible and affects a lot of people and, clearly, that's been up.

Glaser: So, we had this scare in spring, and now we're seeing some more subdued numbers. What's your expectation for the rest of the year? Where do you think inflation will be running?

Johnson: I think we're probably going to still average out in the 1.8% to 2% year-over-year range. Again, that's still higher than the nine tenths of a percent that we got to last year, which was driven by an unusually strong and short-lived dip in gasoline prices. But that's going to be hard to beat this year because we haven't had as much volatility in gasoline prices this year; so, they don't have as far to fall, frankly. I think, toward the back of the year, we aren't going to get that big push from gasoline prices. Maybe we finally start to see some relief in beef prices, but I wouldn't hold my breath.

Glaser: Bob, I certainly appreciate your take on this today.

Johnson: Thank you.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.