March 27, 2009
SAME CRISIS, NEW CHALLENGES
Today's update on personal income and spending reminds that the attack on the consumer rolls on.
As our chart below suggests, the recession is bearing down on Joe Sixpack and the pressure isn't likely to ebb for some time. Disposable personal income was flat to slightly down last month on an annualized seasonally adjusted basis. Personal consumption expenditures fared a bit better, posting a roughly 0.2% rise in February, but that looks like statistical noise and a reaction to the sharp pullback from previous months. Given the sober outlook for the labor market, there's little hope that we'll see much improvement for spending or income any time soon. As the crowd comes to terms with the economic backdrop, we're likely to see ongoing retrenchment in the late, great consumption binge.
But for the moment there's another threat to watch: inflation. Yes, we've been talking about deflation these past few months, and based on the numbers published late last year it looked like the potential for a deflationary spiral was quite real. But it was only a true threat if the Federal Reserve dithered and let deflation take root. As we've discussed, the Fed did no such thing and instead has acted aggressively in combating the threat by flooding the system with liquidity. Given the economic context, a fair amount of the liquidity is sitting idle—i.e., the classic problem of pushing on a string, as they say. Indeed, quite a bit of the newly minted liquidity has been redeployed into nonproductive areas, i.e., safe havens, which is why short-term Treasury bill yields remain at roughly zero, if not slightly negative. When the liquidity starts to come out of hibernation, the potential for inflation will rise.
Meantime, the "D" risk appears to be passing…maybe. And that's while much of the liquidity is locked up in safe havens. The nascent signs of price bubbling is no surprise, even at this early stage. The Fed has been working overtime to deliver higher inflation and there's no reason to think that it'll fail. We've been confident that the central bank would win this war eventually, perhaps sooner rather than later, if it was willing to go the extra mile. Clearly, Bernanke and company haven't been shy on this front, but it may be time to start pulling back.
One reason for thinking so comes by looking at the inflation measure in today's income and spending report. The personal consumption expenditures price index, or PCE Index, is showing signs of stabilizing. To be sure, the February PCE inflation rate remains quite low compared with last summer. PCE prices rose by 1.0% for the year through last month; as recently as last July, the annual pace of the PCE Index was 4.5%.
But a closer look at the components of PCE suggests that inflation, though largely dormant for the moment, is no longer falling. That suggest that it may be poised to reassert itself in the coming quarters. Given all the liquidity sloshing about, that's a real and present danger if we look forward by a year or so, which is typically how long it takes for monetary policy decisions today to ripple through to the broader economy. Much depends on what happens in the next quarter or so, but it's not too soon to consider the possibilities.
On that note, the core PCE Index, which excludes energy and foods, is no longer falling. Last month, core PCE prices advanced 1.8% on an annualized basis, up from 1.7% in January. The Fed targets core inflation generally and it's widely assumed that a ~2% rate on the upside is the goal. Yes, core PCE is still down from 2.4% last July, but a look at the trend since last summer suggests that the pricing trend may be forming a bottom.
Monetary policy necessarily evolves slowly, largely because it takes time to establish confidence about how the economic signals are unfolding in real time. It's all obvious after the fact, but central bankers don't have the luxury of looking at last year's trend for making decisions today. That doesn't mean they can speculate wildly about what may happen. The trick is finding a balance between the two extremes. That's tough in the best of circumstances; these days it's particuarly challenging, given all the volatility.
In any case, we may be at the end of the apocalypse-now realm that has dominated monetary policy since last September. We're not quite willing the declare the war on deflation over, but we're close. Let's see how pricing data looks over the next few weeks.
Meanwhile, we must be mindful of the stagflation risk. That's not an imminent threat, but it's starting to cross our minds these days. Yes, the economy still looks quite weak. But if inflation retains its capacity to bubble higher down the road, even if it's only on the margins, that will complicate the recovery effort and make a strong case for a change in strategy.
In short, the recent optimism that the worst is past is premature. The real work of navigating the financial and economic crises has only just begun. The threat is evolving. What worked for the past six months isn't likely to be effective for the rest of this year into 2010. Wars have a life of their own, and the generals need to stay vigilant. The next phase may be here.
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Posted by jp at March 27, 2009 9:39 AM
it's not going to be real growth. just extra $'s
Posted by: damon at March 31, 2009 1:23 PM
I wonder about inflation.
in the 1990's Japan stimulated heavily and is more indebted than the US. And they have been in deflation and slow growth ever since.
The US consumer is in debt up to her ears, she cannot take on more, factory workers are going back to low wage pay, so where is this HUGE inflation going to come from if wages are flat or falling?
Unlike the 1970's, all us emancipated women are at work already, so this time there is no second income entering the economy to drive prices higher to buy a bigger house and a second car.
The quality European/Chinese/Indian mmigrant is staying home, and except for Iranians fed up with Ahmadinejad, we get the uneducated poor refugees.
Somebody help me - I just don't get it. I still think deflation is the most logical outcome.
Posted by: Anna at March 28, 2009 10:05 PM