I'm going to go out on a limb and call Friday's core CPI for December 2008 as being potentially either the largest monthly decline in percentage terms or close to the largest decline since the Great Depression--a decline of between -0.1 and -0.4 percent. The December numbers will be reported on Friday morning, January 16, 2009 at 8:30 a.m. EST. In the last 50 years, the largest monthly decrease in the core CPI has been -0.3 percent. If my prediction is right, Friday's CPI numbers will surprise markets and kindle some fear about the ability of Congress and the Fed to stimulate the economy enough to prevent a Japan-like deflationary episode. Below is my reasoning for this forecast.
A Bloomberg News survey
placed the median forecast for December's core CPI change at an
increase of 0.1 percent. My price-level pessimism
comes from the level of surprise expressed in the Fed minutes from the
December 15-16 FOMC meeting at the degree to which the economy had
deteriorated at the end of 2008 (see my 1/7/09 post). It is hard to imagine prices rising in
that kind of environment, and they should probably experience a decline at least as bad as October's -0.1 percent.
Core CPI is a more stable measure of overall prices faced by American consumers because it excludes volatile food and energy prices. Also interesting is that any core CPI change less than or equal to zero will make the last quarter of 2008 the largest price decline in core prices for any three month period since the late 1950s, and probably since the Great Depression.
The risk of Friday's core CPI numbers being negative is significant because the main risk to the economy right now, in my mind, is deflation. More declines in the core CPI would signal that the massive amounts of government stimulus injections have not been able to stabilize prices yet. The Fed has run out of its conventional medicine, the fed funds rate, and is now working with economic remedies that are not yet "FDA-approved" (see 12/16/08 post). Congress will be injecting stimulus funds into the economy in 2009 but may not be fast enough to curtail the expectations of the American household that things will get worse before they get better.
What we are trying to avoid is a Japan-like situation in which we have a self reinforcing deflation-recession spiral that policy makers are not able to curtail. This deflation feeds back on itself with a secondary effect when households and firms postpone consumption and investment decisions in the face of falling prices. The main difference between Japan of the 1990s and the U.S. of the present is that Japan's recession was not accompanied by worldwide recession. The current U.S. recession is part of a widespread global recession, so the downside risks of deflation are greater for us today than for the Japan of the 1990s.
Core CPI is a more stable measure of overall prices faced by American consumers because it excludes volatile food and energy prices. Also interesting is that any core CPI change less than or equal to zero will make the last quarter of 2008 the largest price decline in core prices for any three month period since the late 1950s, and probably since the Great Depression.
The risk of Friday's core CPI numbers being negative is significant because the main risk to the economy right now, in my mind, is deflation. More declines in the core CPI would signal that the massive amounts of government stimulus injections have not been able to stabilize prices yet. The Fed has run out of its conventional medicine, the fed funds rate, and is now working with economic remedies that are not yet "FDA-approved" (see 12/16/08 post). Congress will be injecting stimulus funds into the economy in 2009 but may not be fast enough to curtail the expectations of the American household that things will get worse before they get better.
What we are trying to avoid is a Japan-like situation in which we have a self reinforcing deflation-recession spiral that policy makers are not able to curtail. This deflation feeds back on itself with a secondary effect when households and firms postpone consumption and investment decisions in the face of falling prices. The main difference between Japan of the 1990s and the U.S. of the present is that Japan's recession was not accompanied by worldwide recession. The current U.S. recession is part of a widespread global recession, so the downside risks of deflation are greater for us today than for the Japan of the 1990s.
