Don't Worry About Inflation?

Don't Worry About Inflation

Unfortunately, it is very difficult to predict what the future holds for inflation. We cannot properly estimate global commodity demand and it is almost impossible to forecast an oil price spike that would be similar to last year's bubble.

It is very difficult to predict what the future holds for inflation and yet we're told not to worry about it? I am now beating my forehead against my desk. Why did I continue to read the article? I must be a glutton for punishment.

Everyone should worry about inflation. It's been the long-term trend for a century. You can worry about deflation too if you like. I am. Not worrying about either of them is a great way to lose one's nest egg.

Using fundamental economic modeling, the odds of high inflation over the near term are extremely unlikely.

Is this the same fundamental economic modeling that Bernanke was looking at when he said there was no housing bubble to go bust?

The odds of my house burning down are extremely unlikely in the near term too. I still have fire insurance though. Ever try buying insurance once the fire trucks are parked outside?

The most widely used theoretical model for examining inflation has been the Phillip's Curve. In most undergraduate macroeconomics courses, the Phillip's Curve is depicted as the relationship between unemployment and inflation.

An increase in unemployment causes inflation to decline.

Now you know why economics is considered the dismal science. Theories are often more important than facts. Here's the chart of the Phillips Curve from 1948 to present. I made it myself today. The blue dot represents where we are now.



What pattern do you see in the data? I see a cumulus cloud formation. Maybe I can be an economist too? The trend line isn't exactly backing the Phillips Curve theory either, is it? If anything, it suggests that higher unemployment and higher inflation in that very noisy data set go hand in hand. I guess there must be more to it than that.

What could possibly cause high unemployment and high inflation at the same time though? It makes no sense. It would mean that undergraduate macroeconomics courses are teaching the wrong things. Hey, maybe we can ask Zimbabwe. They successfully managed to get 94% unemployment AND hyperinflation. They ought to be able to give us some advice.

If money is not demanded, goods are not purchased, and inflation cannot increase.

It can't? I guess that completely rules out any sort of currency crisis. You know, our "money is not demanded" by foreigners any longer. Thank goodness that can't happen. We wouldn't want to suddenly find ourselves trying to buy goods from them with something they no longer want. As a side topic, I wonder how much oil would cost if we could no longer purchase it?

The market does not expect inflation to become a problem.

Would this be the very same market that was completely and utterly blindsided by deflation recently (as seen in his very chart)? Or is this the market that the dotcom bubble and housing bubble sneaked up on? Or is this the other market that has pushed gold up to $1000 an ounce? You know what? Maybe I'll pass on what the market(s) thinks when it comes to long-term inflation expectations.

By the way, as a non-economist I am VERY skeptical of using TIPS to determine inflation expectations of the market. Those convinced that deflation is coming can and do buy Treasuries. Those convinced that inflation is coming aren't going to be buying TIPS though. They are going to be buying oil and other natural resources instead. I am actually in the middle ground. I worry about both deflation and inflation. Therefore, I do like TIPS.

If I am right to be skeptical about using TIPS to determine inflation expectations, then inflation should actually run hotter than the markets think. In other words, there will be less demand for TIPS than there should be. If I was an economist, I'd argue that less demand for something I buy is a good thing. It means I bought it cheaper.

I may lean towards deflationary thinking in the short-term, but I'm not at all done worrying about inflation long-term. Call me paranoid. I will conclude with one thing I do agree with the author on. It is very difficult to predict what the future holds for inflation.