Today’s report on inflation is sure to cause some long faces among economy worrywarts. It should instead draw smiles.
The Federal Reserve’s favorite measure of inflation showed that prices rose faster in May than they have in three years. Overall, the consumer price index indicated that U.S. households are spending 3.6% more to buy the same goods they did a year ago. That jump in prices was higher than forecasters expected. And that has caused some people to say that we are entering a period of stagflation – which is when both unemployment and inflation are high, a dangerous mix that is often worried about but rarely occurs.
Nonetheless, after a string of bad economic news, which has led many to ponder the risks of heading into a double dip, the uptick in inflation is a good sign. Here’s why:
Inflation is a sign of economic activity. Just ask China. Inflation in that country is running in the double digits. Yet, China’s growth economy seems to be what everyone wants right now, except, that is,China, which is raising interest rates to slow inflation, and eventually growth. The point is that you can’t have one without the other, or the other way around. A few months ago, the expectation was that inflation was going to be running in the high fives or low sixes on an annual basis at this point in the recovery. And that had people nervous. But as the economy weaken this year, economists have cut back their estimates. They expected the CPI this morning to say that inflation in the past year was 3.3%. Instead, it turns our prices rose 3.6%. That’s a sign that the economy is strong than expected, not weaker. If economist have 3.3% inflation worked into their model and it is rising faster than expected, you might expect overall growth to outperform as well.
Now, one thing you should watch out for is people trying to have it both ways. For most of this year, the Federal Reserve and others who watch inflation have said that core inflation, which excludes food and energy, is a better measure of future price increases. And that appears to be correct, though I have some doubts as to whether that is always the case.
Still, when general inflation was rising, mostly driven by gas prices, the Fed was able to point to the tame core inflation numbers to say that prices weren’t going to rise for long. Now core inflation appears to be rising. Still, many are going to say this is nothing to be worried. The rise in gas prices in the first five months of the year are just working their way through the system, causing everything that has to be shipped or manufactured to rise in price. Now that gas prices are falling – CPI data said they were down 2% in May – those prices should fall as well. But that can’t be the case. If you really believe core CPI is a good measure of future inflation, than today’s rise in prices for everything other than food and energy should signal that prices are likely to continue to rise for some time. And in an economy badly in need of growth to create jobs, a sign that prices will continue to rise is a good thing, not bad. Smile.