by CalculatedRisk

From MarketWatch: Consumer prices jump 0.8% in July

U.S. consumer prices jumped a greater-than-expected 0.8% in July, marked by big increases in energy, food, clothing and cigarettes, the Labor Department reported Thursday.

The core consumer price index - which excludes volatile food and energy prices - rose 0.3% for the second straight month.
...
Consumer prices are up 5.6% in the past year, the biggest year-over-year increase since January 1991. The CPI has surged at a 10.6% annualized rate in the past three months.

Click on graph for larger image in new window.

This graph shows the year-over-year change in inflation, both CPI and Core inflation (less food and energy). Using CPI, inflation is at the highest level in 17 years.

Also note that CPI has persistently been running ahead of Core for most of the last 5+ years. This is mostly due to the huge increase in energy prices (and food too).

The good news is inflation should slow as energy prices fall (if they continue to decline). And inflation helps with real house prices too!

by CalculatedRisk

Professor Tim Duy writes at Economist's View: Misunderstanding the CPI. This is an excellent discussion of CPI, and review of David Loenhardt's article yesterday in the NY Times: Seeing Inflation Only in the Prices That Go Up.

Also, here is a great graphic showing the relative size of all of the components of CPI: All of Inflation’s Little Parts (hat tip Eyal). Notice the size of "owner's equivalent rent" (OER).

Dr. Duy discusses OER and then concludes:

[T]he debate over the use of OER in the CPI is something of a false debate. In my opinion, it misses the point entirely. The debate is not whether housing costs are miscalculated in the CPI – the BLS’s basic methodology is appropriate to achieve their objective. The debate is whether or not the Fed should include assets prices, such as home prices, in their policy objective of price stability. Just because there is a valid argument that the Fed should be using a measure other than (or in addition to) consumer prices does not imply that the CPI is flawed. It implies that the construction of monetary policy is flawed. In effect, the BLS is unfairly criticized for the Fed’s policy error.

by CalculatedRisk

Here are two scary stories:

From CNN: Riots, instability spread as food prices skyrocket

Riots from Haiti to Bangladesh to Egypt over the soaring costs of basic foods have brought the issue to a boiling point and catapulted it to the forefront of the world's attention, the head of an agency focused on global development said Monday.

From the WSJ: Russian Output Slumps As Oil Hits New Highs

Russian output fell for the first time in a decade in the first three months of this year, according to the International Energy Agency, which represents industrialized oil-consuming countries. It said Russian production averaged about 10 million barrels a day, a 1% drop from the first-quarter of 2007.

These stories are related. High food prices are due in large part to high oil prices.

Falling oil prices would really help cushion the U.S. recession. If oil prices stay high because of global demand - then at least U.S. exports will probably be strong. But if oil prices stay high because of falling production, then the recession will be much worse than I currently expect. And the impact on the World's poor will be severe.

These stories are much scarier than the TED spread expanding again.

by CalculatedRisk

From the WSJ: Import Prices Show Pervasive Jump, Even When Oil Costs Are Excluded

Import prices surged in March, lifted by not only oil but also the biggest jump in nonpetroleum costs on record, a worrisome sign for inflation.

Overall import prices rose 2.8% last month, after increasing an unrevised 0.2% in February, the Labor Department said Friday. ...

During the 12 months since March 2007, prices increased 15%. ...

Excluding petroleum, all other import prices rose 1.1% in March, after increasing 0.7% in February. Prices excluding petroleum increased 5.4% in the 12 months since March 2007, nearly double the 2.8% climb between March 2006 and March 2007.

Rising import prices have a somewhat small impact on U.S. inflation, because total imports (about $2.3 trillion in 2007) are relatively small compared to GDP ($13.8 trillion in 2007) - or about 17% of GDP. But the 5.4% increase in import prices does add - as a rough estimate - about 1% to U.S. inflation.

Also, increases in the trade deficit, associated with rising prices (as opposed to more imported goods and services), is unwelcome news.

by CalculatedRisk

From Professor Delong: Sounding the Alarm on the Financial Crisis

"Stage III of a financial crisis is when a central bank runs out of ammunition--when pushing interest rates too the floor and swapping out all of its assets does not restore the good equilibrium. Then you face a threefold choice: depression, inflation, or public intervention. Depression is to be avoided. Inflation--resolving the financial crisis by printing enough money to boost the price level far enough that all of a sudden everyone's incomes and real asset values are high enough to pay off their nominal debts--is generally best avoided too. As John Maynard Keynes wrote more than eighty years ago: "The Individualistic Capitalism of today, precisely because it entrusts saving to the individual investor and production to the individual employer, presumes a stable measuring-rod of value, and cannot be efficient--perhaps cannot survive--without one."

So if Depression is unthinkable, and inflation is best avoided, this leaves public action. If the good equilibrium has vanished - as it looks like it has - because the supply of risky assets is too large for financial intermediaries to want to hold them given their capital, then the central government has to take action: to boost or to make financial intermediaries boost their capital so that they will demand more risky assets at high prices, and to diminish the supply of risky assets offered on the financial markets by either a) guaranteeing some of them or b) by buying up some of them itself.

It's time to start thinking. If we don't want to wind up in a deep depression or a big inflation, it is time to recognize might well run out of ammunition in dealing with this financial crisis, and figure out what kind of government action we want to see, and how we can set in in motion quickly if it becomes necessary."

I do not believe we've reached what Professor DeLong calls Stage III of a financial crisis - and I don't think the Fed is out of ammunition - but I think DeLong is correct that we should be planning ahead. The Fed can only do so much, and DeLong is arguing we should be prepared if it becomes clear the Fed is ineffective.

Along those lines, Professor Krugman writes: Weird Interest Rates.

Treasury rates have plunged close to zero, even though Fed funds is still 2.25%. Since open-market operations take place in Treasuries, I take this to mean that the Fed may not actually be able to reduce short-term rates much from current levels — which means, in turn, that conventional monetary policy has been taken off the table.