Even in a Slow Economy, Inflation Can Still Strike

Jason Stipp: I'm Jason Stipp for Morningstar. The great inflation-deflation debate got a little bit more data this week with a couple of government reports. Here with me to offer his take on the conversation and also what he saw in the reports is Morningstar's Bob Johnson, director of economic analysis.

Thanks for joining me, Bob.

Bob Johnson: Great to be here.

Stipp: So we did get a couple of reports this week, the CPI and the Producer Price Index as well. Those are generally what people look at to see where is inflation--what kind of inflation do we face. What did you see in those reports?

Johnson: I really focused on the Consumer Price Index this week and the headline number was up a couple of tenths of a percent, which was a little better than people had hoped for. And I frankly like a low number, I mean that annualizes into about 2.4%, and I think it's a very good number.

What I'm very fearful of is if that inflation gets too high, and we've had relatively modest wage growth, that that takes away all the benefit from the little bit of wage growth that we've got. So, I'm not in the camp that's massively scared of low inflation or even a little bit of deflation.

Stipp: Now, you mentioned the headline number, another way that some economists will look at that number is the core number, so they will take out the volatile things like gas and food prices. The core number was actually pretty flat.

Johnson: Yes.

Stipp: There really wasn't any inflation at all. What do you make of that number as proof that we're not seeing any inflation and might see some deflation.

Johnson: Well, not only that, but it has been flat for three months. It's been 0.0 for three months in a row. So, the core number is ex-food and energy, and, you know, there is a certain logic to leaving those out; they are volatile, and they can be up and down in a given month.

But I am a very big believer in that you don't just willy-nilly leave them out of the calculations. I think they are important things--things that people cannot avoid buying, and so they're really the guts of inflation and what people are paying for, and it's what makes a difference about how optimistic people feel, and what they can spend on other goods in our economy, especially goods manufactured in our own country.

So, I think that's certainly more important to look at that headline number. Now, certainly, if you have a one-time refinery fire that makes it go up one month and by the time the report comes out, you already know the refinery has been fixed and you can do a manual adjustment. But just willy-nilly saying, "oh, well, energy doesn't count," it is ridiculous.

<TRANSCRIPT>

Stipp: These are still costs that people have to pay every month, even if they are going up and down in a yo-yo fashion.

Johnson: Exactly.

Stipp: I think the Fed, definitely, with some of its policy actions recently, really is showing that it's wanting to put up a front against deflation, and deflation seems to be the thing that most people are afraid of at least in the short term. Is a little bit of deflation bad? Should we really be concerned about a Japan type of scenario if we see any deflation? What's your take on that?

Johnson: I think that's the fear. I mean the fear is that if you have deflation, we'll end up like Japan, which means no growth in employment and continuing to fall prices. But keep in mind even the Japan situation is not going down 5% to 10% every year or something like that, and I'm thinking deflation a little bit here and there is not an all bad thing. I mean, I certainly am not a fan of seeing deflation, and it's a little bit harder to control deflation than inflation, which is the Fed's concern. But from a statistical standpoint, when we've had times in the '50s when prices have been a little bit soft and a couple of other era after a recession when pricing has been soft, and it's actually been beneficial for markets and for overall growth.

We've already seen, unless the goods are on sale in the store that people tend to stay away, and when people are offered a good bargain, they'll take it, and they just don't want to get taken to the cleaners, so to speak, and so they are very careful on pricing. And I don't think that they're staying away from buying everything altogether.

Stipp: You mentioned that there sometimes can be pockets for pricing that may be a little bit softer and maybe also some pockets where could see a little bit of inflation. Are you seeing any signs of inflation specifically down the ladder a little bit, some things that you're keeping a close eye that might worry you a little bit.

Johnson: Well, I always keep my eye on a few things and obviously, the housing component of it right now, which is 40% of the index, is keeping a nice lid on things--and that's 40% of the index. So that's certainly keeping a lid, and if rents start to move up, then I have to worry a little bit, but so far we are okay there, and so that's one that I watch longer term.

Short run, we've had a huge runup in used car prices, to the point where about a month or two ago, it actually cost more to buy a used car than the new car because the loans, if you recall, are much more expensive on a used car than a new car. So, monthly payments were actually higher for a brief period on used cars. Now that's kind of turned around a little bit and used car prices were actually down almost a percent last month. So, interesting things are happening on that front.

And apparel is another one where we had a very warm fall and people didn't buy the winter clothes and the retail had to close some stuff out, and so we saw a pretty hefty decline in apparel price despite what you're hearing about all the stuff with cotton and everything else. We are going to see that in months ahead, but not right now.

Stipp: So, it's potentially a temporary depression in the prices there, but it could come back.

So, looking a little bit broader and a little bit longer term, I think a lot of the folks who are worried about deflation, the deflationists, are saying there is still a lot of slack in the economy. The unemployment rate is still high. They just don't see that demand is going to be there to really push prices up.

So, what's your take on that? Can we see inflation while we are still seeing an elevated unemployment rate? Is it possible that we might have both evils to content with?

Johnson: Unfortunately we might. And I think that's what we have to be real careful about. You've got certain packets of things that are expensive, and one of the phenomena that you are seeing is that United State is not the price setter on every good and every commodity anymore. I think the prices are largely set in developing markets, in China in particular. You look at some of the raw commodities, the copper, the soybeans, the cotton--prices are up 20%, 30%, 40% over the last year. I mean they are pretty dramatic numbers.

And that's all happening in the face of slack U.S. employment now. So I think that people saying, "well, just because we have got slack here means that, oh, there is never going to be any problem with inflation," it's just misplaced.

Stipp: Certainly it doesn't make any sense to turn your back on the possibility for inflation altogether.

Johnson: Right.

Stipp: Bob thanks so much for joining me and for your insights on the inflation and deflation debate.

Johnson: Thank you.

Stipp: For Morningstar, I am Jason Stipp. Thanks for watching.