No New Normal for Inflation
Peter Warburton - 18 June 2020
The crass repetition of this unfortunate epithet has inducted “New Normal” into the realm of cliché-dom. It loosely translates as: “the good old days are gone, so we had better come to terms with something less”, as in slower economic growth, lower interest rates, lower investment returns. Yet “New Normal” also smuggles in the assertion of a new stability, a settled state, at the new, impoverished, level. There is no New Normal in sight for inflation. As much as governments and central banks would love to tether inflation to a stake, this wolf has broken loose. We all have blurred vision when it comes to the near-term evolution of the general price level in the face of dramatic inventory adjustments, disrupted supply chains, dislocated workplaces, displaced labour markets and increasingly desperate authorities.
At this time of year, Economic Perspectives usually hosts a breakfast seminar in London on an inflationary topic. In these straitened times, we are working up to an inflationary webinar (Zoom call) on Tuesday 7 July instead. Last June, our seminar was entitled “Blowing up the box!”, referring to the policy box or framework that has been our point of reference for the past 30 years. A previous seminar, in October 2018, was entitled “Who will save the world from 2020 peril?” Coronavirus was not the peril that we had in mind, but it has brought fresh relevance to the question. And Coronavirus, rather than US politics, has truly “blown up the box”, persuading supposedly market-friendly governments in America and Britain to adopt profoundly socialistic interventions, which undermine the whole framework of inflation control and conventional monetary policy.
There is a popular narrative, termed “The Great Moderation” that describes a decline in macroeconomic volatility in the decades prior to the Great Financial Crisis. Its focus is principally GDP and employment growth, but some accounts include wage and price inflation. Abstracting from swings in inflation driven by movements in food and energy prices, core inflation volatility at a monthly frequency has trended down notably since the 1960s. However, a study by Edward Hulseman and Alan Detmeister for the New York Fed in 2017 found that inflation’s annual volatility in the US during the 1990s and early 2000s was not much different to that of the 1960s. They discovered that the decline in monthly volatility was mainly an artifact of data construction. Specifically, the volatility of changes in monthly core CPI inflation since the 1960s is the by-product of changes in seasonal adjustment methodology, rebasing and rounding procedures, and the calculation of shelter inflation. After accounting for these factors the moderation in changes to monthly inflation rates largely disappears (figure 1).
If there was no “Great Moderation” in inflation volatility in the 1990s and 2000s, we can be even more confident that there will be no “New Normal” in the wake of Coronavirus. We already observe (figure 2) an uptick in core CPI volatility (still measured on a 1-month annualised basis, using seasonally unadjusted data and across a 60-month window). The intriguing real-time indicator of US consumer prices, known as PriceStats, has also turned upwards in recent weeks, possibly presaging a disturbingly imminent inflation surprise (figure 3). Forget the New Normal and prepare for the Old Peculiar!
Figure 1: Standard deviation of change in 1-month annualised inflation (Core CPI excluding shelter, 60-month rolling window)
Data source: Thomson Reuters Datastream
Source: State Street Advisors
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