Our standard measure of inflation, the Consumer Price Index excluding Food & Energy, continues to slowly fall. Many economists, including Krugman (loudly) and Bernanke (cryptically) are warning of potential deflation. Falling prices sound good to the individual, but collectively it can create a pattern of delaying purchases until prices fall more, which leads to lower employment and starts a vicious cycle of unemployment.
But are we facing general deflation? So far, I would say that we aren't. Much of the falling inflation that we see is caused by the falling shelter component of the CPI. Small price changes in shelter move the overall CPI by a lot because it is the largest component, making up 32% of the consumer's total basket of goods and services. The overall inflation rate, once shelter is excluded, isn't that different in the past year than the average over the past decade, or even that different from the decade prior to the financial crisis (pre-2007).
You'll notice that the inflation rate of shelter isn't falling as much as house prices have. That is because the CPI doesn't use the actual cost of house prices in its measure of shelter price, but instead uses rent and an estimate of what rent would be. This may sound strange, and probably reduces the volatility of house prices - though on the other had, home owner's mortgage costs don't change every month with the price of their house.
I realize that removing shelter, food, and energy seems silly; since that makes up 57% of the average consumer's spending. But the point is to see if we are getting a general deflation trend. Energy is typically excluded because the prices bounce around like a super ball; it just confuses any long term trend. To a lesser extent, the same is true of food prices. When we look at the cost of other consumer expenses, some are falling - but many aren't. Cars, medical care, and education have inflation rates similar to the past. Household furnishings are falling faster than they have in the past, probably largely due to fewer new houses to furnish and decorate. Apparel prices are falling, like they have for many year - probably due to low cost imports and currency controls with those exporters. All in all, it is a mixed bag. Inflation may move a bit lower, but it doesn't suggest general and significant deflation.
Falling shelter costs in the long run isn't necessarily bad, because most of the higher cost goes to competition for land rather than higher consumption of job producing goods and services. Lower shelter costs (and rent in general) increases the disposable income and quality of life for the average consumer - though admittedly it doesn't look as good on many people's balance sheets
A falling dollar should put continued upward pressure on the cost of imported goods. Does that mean we are likely to have significant inflation? With this unemployment rate, the typical wage/price spiral seems very unlikely. And the Fed's creation of money so far appears unlikely to lead to the increased consumer lending that would drive up demand and prices for goods and services.
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