Prospects for Inflation outside America – Guest Post from Menzie Chinn

Menzie Chinn, Prof. of Economics at University of Wisconsin, is guest posting this week:

I want to thank Jeff Frankel for the opportunity to be a guest writer on his blog.

A lot of attention has been devoted to how oil price and food price shocks have affected the US economy, both along the output and price dimensions. A general presumption has been that as long as inflation expectations remain well anchored, then one need not worry about 1970’s style stagflation (recession is another matter).

However, there are many places in the world where inflation expectations are not well anchored. Or at least we can’t tell if they’re well anchored or not. Figure 1 presents data for several key groups (using the IMF classifications): Industrial countries, LDCs excluding oil exporters, oil exporters and developing Asia.

Figure 1

Figure 1: Inflation rates defined as 12 month changes in CPIs, in selected groupings: Industrial countries (blue), oil exporters (black), developing countries excluding oil exporters (red) and developing Asia (green). NBER defined recession shaded gray. Source: IMF, International Financial Statistics accessed June 20, 2008.

It’s clear that inflation is surging in the oil exporting countries. This is occurring as reserves balloon (see Brad Setser has diligently tabulated on a number of occasions; e.g., [1]), often under pegged-to-the-dollar exchange rate regimes, and the monetary authorities are unable to sterilize money base expansion. Here, I can’t resist writing the identity:

Money Base = Foreign Exchange Reserves + Net Domestic Assets

As foreign exchange reserves increase, money base must increase, unless the central bank can (and will) sterilize by making offsetting reductions in net domestic assets.

This is why Feldstein has called for de-pegging from the dollar for oil exporter currencies [2] (for contrasting recommendations, see Paulson’s comments [3]).

Of course, this mechanism does not apply in all instances, there are oil exporting countries not under fixed exchange rates, but reserve accumulation nonetheless is making its way into money base creation. As government revenues increase, spending is also pushing up prices.

So, no surprise that inflation is rising in this group. But what is surprising is how much inflation has risen in the non-oil-exporting LDCs, and in Developing Asia (this group excludes NICs like Korea).

Figure 2

Figure 2: Inflation rates defined as 12 month changes in CPIs, in selected East Asian countries: China (red), Malaysia (blue), Philippines (green), Thailand (black), Vietnam (teal). NBER defined recession shaded gray. Source: IMF, International Financial Statistics accessed June 20, 2008.

Inflation has risen as food and energy prices have risen. Vietnam is the most striking example. And China, of course, has been in the spotlight, largely because of its economic mass. But note how Thailand and the Phillipines inflation rates have accelerated.

Now one might say this is all obvious – – but in several of these countries (e.g., China), energy prices were heavily subsidized. Raising these subsidized prices will – – in a mechanical fashion – – raise the recorded CPI. If prices were perfectly flexible, higher energy and food prices only represent a higher relative price for these goods. I’ll let the reader determine for him or herself whether that’s a plausible assumption. In any case, the net effect over the longer term is uncertain. Raising the subsidized prices means higher prices on those specific goods (possibly feeding into wages). But the lower government outlays for subsidies means smaller deficits (holding all else constant) and hence lower money base creation.

Is there hope to be derived from the fact that there are more inflation targeters now than there were during the previous episode of inflationary pressures, three decades ago? In a paper written two and a half years ago, Andy Rose documented the fact that inflation targeting has proven to be a relatively durable form of monetary regime. That is, compared to the “fixed” exchange rates, an average duration of an inflation targeting regime is longer. One observation I would make is that most of those inflation targeting regimes were implemented in a relatively benign global economic environment – – at least benign from the inflationary standpoint. While oil prices have been rising since 2002, it appears that the surge in food prices, on top of oil and non-food commodity prices – – is what has changed matters (Figure 3 recaps a graph from this post).

Figure 3: Log indices. NBER defined recession shaded gray. Source:.
(Of course, these oil and food price shocks may end a lot of exchange rate reimges as well).

By the way, Thailand and Philippines are classified as inflation targeters by Rose. Korea, also classified as an inflation targeter, has also experienced accelerating, but nonetheless lower, inflation (at about 4 percent). So, the jury is still out on the question whether the commitment to inflation targeting during this episode will result in a substantive difference in how matters play out.

On a more speculative note, one idea that has struck me is that, as inflation rates rise, it may become more difficult for the East Asian countries to maintain their exchange rates against the dollar at their current levels. Recalling (in logs):

qj = s – pj + p US

In words, the real exchange rate for country j against the USD (defined as up is weaker) will strengthen as the domestic price level rises, holding all else constant. That may in turn a be a harbinger of the end of the tendency for the East Asian countries to export capital to the US (although the overall US current account balance will tend to remain driven largely by domestically driven by the saving/investment balance in the US, and we know where the current trajectory of the US budget deficit is going…[4]).

Figure 4: Trade weighted broad real currency values, in logs. NBER defined recession shaded gray. Dashed line is at June 2005, the month before the CNY revaluation. Source: BIS accessed June 23, 2008.

So far, this remains speculation. However, over the past couple months, China’s real currency value has appreciated in trade weighted terms, which is remarkable when one keeps in mind the dollar’s depreciation over this same period. It remains to be seen whether the other currencies follow suit. That may hinge upon how these countries respond to inflationary pressures.

I am going to turn off the “Comment” function on my blog

Since I started this blog, my comment section has been inundated with spam.   I am not talking about bona fide comments, most of which have been intelligent and useful.   I’m talking about thinly disguised bids for sales of pornography, mortgage quotes, and other parasitical activities.    The spam has reached 35 per night, and it is time-consuming to go through it all.  For some reason I don’t understand, my software can’t  filter it out, even though other bloggers don’t seem to have this problem.

Hence I will soon turn off the comment function.    I am sorry about this.  Many of my posts will be carried by Roubini Global Economics from now on.  Readers who have access to RGE may post comments there, and I will check periodically.

Did GDP Fall Within the 1st Quarter or Not?

Over the past month, I , citing Feldstein, have said that if one looks at available information on monthly GDP, available from estimates of MacroAdvisers, that output declined within the first quarter of the year, even though as standardly reported GDP was higher in QI overall than it had been in the last quarter of 2007.   But, as it turns out, there is some ambiguity to the question.   

The estimates do show GDP falling in February, by a hefty 10.1% anualized.   But the numbers for January and March are up.    To net out the three months, one must split hairs.     The positive numbers for January plus March are just slightly greater in absolute value than February’s negative 0.9 (monthly).   So the net is up?   Not necessarily.

We are trying to figure out the change within the quarter, from beginning to end.   Technically, that means from January 1 to March 30.  But of course even Macroadvisors doesn’t report daily or weekly estimates.   Estimated total real GDP in the month of March was just slightly above total real GDP in the month of December.   So again the net is up?   The most precise measure of the change between January 1 to March 30 is the change between the December-January average and the March-April average.     That is a tiny negative number:   GDP fell by an estimated $28 billion within the first quarter (in year-2000 $).  And April is so flat as to be essentiallz zero.

I think I am sorry I brought the subject up.

It would in any case be a mistake to make much of these numbers.  The reason the Commerce Department’s Bureau of Economic Analysis doesn’t report monthly numbers is that the data are so unreliable, and subject to revision.   For anyone who needs some sort of estimate of monthly GDP, as we do on the NBER Business Cycle Dating Committee as an input into our thinking, this is what we have to go on.    But one sees here yet another illustration as to why the BCDC waits a long time, until all the data are in, before declaring a recession.

Are Either Low Interest Rates or Speculation Raising Holdings of Oil and Other Minerals?

Everyone is looking for someone to blame for high prices of oil and other mineral and agricultural commodities.    Speculators (among others) are high on the list, followed by the Federal Reserve.    While I don’t think blame is necessarily the right concept here, I have been arguing that low real interest rates have worked to raise real commodity prices through a number of channels.  Each of these channels could be called “speculation,” if speculation is defined as behavior based on expectations of future prices.

A number of commentators, including Don Kohn and Paul Krugman, have argued that low interest rates and speculation cannot be the sources of the problem, because oil inventories are low.    It is true that low interest rates, other things equal, should in theory increase firms’ desire to hold inventories.

US Inventories of crude oil, 1998-2008

US crude oil inventories do not appear to be especially low in the graph above, showing June 1998-June 2008 (from Bloomberg).  But it is true that they are not especially high either.

We are talking about relatively integrated world markets, however, so it is world inventories that should matter most.     According to the International Energy Agency’s Oil Market Report, oil inventories held in developed countries have been above average during most of the last year, as the next graph shows.OECD oil inventories above long-run average  They rose sharply in January 2008, which happens to be the month when the very aggressive cuts in US interest rates took place.Inventories of Crude Oil in Rich Countries Above Long Run Average  These numbers are far from conclusive, but still…
Inventories of Crude Oil in Rich Countries Relative to Long Run

The theory is meant to explain the mystery why prices of virtually all mineral and agricultural prices are high, not just oil, and in some ways fits others better.     Inventories of some commodities are indeed high now.   The price of gold, the last graph shown, is a good example.   Here the evidence supports the theory (1) that easy monetary policy has driven up the price, and (2) that one channel is low interest rates making it more attractive to stockpile the yellow metal.   But, as with oil, the biggest inventory is the one underground.

Inventories of gold

[Thanks to Pravin Chandrasekaran.]

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