For the second month running, consumer prices fell. And by more than a little, invoking the specter of deflation once again.
CPI slumped by a hefty 1.7% in November on a seasonally adjusted basis, the government reports today. That follows October’s 1.0% fall. More dramatically, last month’s tumble is the deepest monthly decline in CPI since the Labor Department began keeping records on this series in 1947. Meanwhile, MarketWatch.com reports that the 1.9% non-seasonally adjusted fall in CPI is the steepest monthly rate since January 1932—the height of the Great Depression.
Meanwhile, core CPI (which strips out food and energy) is unchanged, following a slight decline in October. As this is the Fed’s preferred measure of inflation, even a central banker can’t deny that inflationary pressures have evaporated, at least for the time being.
Looking at the more familiar year-over-year calculation of headline CPI, consumer inflation is still positive, running at 1.0% for the 12 months through November. Even so, that’s down sharply from October’s annual rate of 3.7%. At this rate, CPI will soon be falling on an annual basis too.
As striking as the news is, a decline of some magnitude in CPI was expected, partly based on the earlier report of the ongoing decline in producers prices. Nonetheless, the sight of broad price indices sinking month after month in both the consumer and wholesale markets raises the question of whether this is merely a temporary state or something with more endurance?
We’ve been writing about rising deflation risk for some months now, and it’s clear that the beast is here. It’s still unclear how long it lasts, and so for the moment one can be optimistic that an unhealthy downward spiral in prices isn’t fate.
Keep in mind that the massive monetary stimulus engineered by the Fed has only partly filtered into the economy. Monetary policy has a fair amount of lag time, perhaps a year or more. With each passing month, the aggressive liquidity injections will work deeper into the consumer and business sectors. Few expect a sudden rebound in spending and lending, but at this point simply keeping prices steady would be no small accomplishment.
Another reason to think that prices may soon stabilize comes from the fact that heavy drops in energy prices are currently leading CPI’s descent. The energy component of consumer price inflation has lost ground for four months straight, with November’s whopping 17% fall the biggest so far. But energy prices can’t keep falling off a cliff month after month. Yes, the world economy is headed for tough times, which is paring demand for oil, gasoline and other fuels. But the lion’s share of the price cutting relative to the highs of last summer is behind us.
There may yet be more declines in energy coming. In fact, we expect as much. But the magnitude of future declines, if any, will almost surely be smaller. Nor is it unreasonable to expect that energy prices generally will soon tread water, albeit at substantially lower levels compared with recent history.
As for the other components of CPI, well, that’s another story. The transportation slice of consumer prices retreated by nearly 10% last month—the fourth month in a row of red ink. Housing prices are weakened last month, although just barely. But not every is posting price discounts. Prices for food, apparel, education/communication and medical care all managed to rise last month. Deflation hasn’t yet infected everything, and therein lies more reason for hope.
Still, no one will wonder why Fed funds futures are pricing in a 50-basis-point cut at the Fed’s FOMC meeting later today. If accurate, that would bring the target Fed funds down to 0.5%. As extraordinary as a 0.5% will be in historical terms, at this point it’s something of a formality to reflect reality since the effective Fed funds (which is based on actual banking activity) is already at a scant 0.14%.
In sum, the war to head off inflation is in full swing. The Fed can’t afford to fail in this battle. Allowing deflation to build a head of steam at this point is tantamount to economic suicide. It must be stopped, even at the risk of letting inflation out of the bag down the road. Controlling inflation, after all, is well understood, even if the political will isn’t always there. Fighting deflation, by contrast, is far tougher and so pre-emptive medicine is preferred.
The challenge before us is defeating deflation with unconventional monetary policies, supported by aggressive fiscal stimulus. Since there’s not a lot of precedent for the former, one might reason that the fiscal side of the ledger will have to do the heavy lifting, which necessarily depends on the political process. ‘Nuff said.
Yet the task is not insurmountable. Indeed, monetary and fiscal policies will be that much more effective if consumer prices merely stabilize in the coming months, or at least stop dropping so rapidly. But that, as they say, is a big “if.” Stay tuned.