The recent crisis was marked by a demand crisis that was felt most harshly in real estate credit markets. So, core inflation (less shelter) is mostly a reflection of demand. But, since real estate has been limited by the crisis in real estate credit markets, shelter inflation is a reflection of a supply shock. Further economic recovery will be difficult without further recovery in real estate credit.
Core minus Shelter inflation was strong in late spring, but has now fallen for four consecutive months, including two months of core deflation.
I think we need to have home leverage back to normal levels and a natural interest rate above zero in order to escape, and these things will happen together or not at all. Both are marginally there now. The recovery is happening in many facets - employment, foreclosures and loan-to-value, commercial and industrial credit, consumer credit, consumer confidence, service and manufacturing indicators, etc. There are an awful lot of things pushing us in the right direction. But, this inflation report leaves open the possibility of a slowdown before we get there.
Looking ahead, if the Fed is targeting inflation, we might be looking at a sort of tipping point. If continued real estate credit recovery leads to new home building and a decline in shelter inflation, the Fed might be lulled into getting too far behind rising demand. But, if real estate credit stagnates, and a supply shock in shelter causes inflation to surge, the Fed might miss the underlying deflationary trend. Politically, it would be very difficult for the Fed to open up another round of liquidity injections. This outcome could be disastrous.
I'm still positioned for the expansionary outcome. But it bears watching.
Excellent blogging. There is a long history and controversy over housing costs and the measurement of inflation. So...why obsess about inflation and not real growth?
ReplyDeleteTravisV here.
ReplyDeleteParts of this analysis just don't feel right........
Scott Grannis: "The return of King Dollar"
I find it difficult to parse currency fluctuations. It sounds like Grannis has some of the concerns I do about tightening too soon. Am I reading that right? Where do you stand?
DeleteTravisV here.
ReplyDeletehttp://scottgrannis.blogspot.com/2014/09/the-return-of-king-dollar.html