Wednesday, July 1, 2009

Inflation and Investor Sentiment



The easy monetary policy at the end of 2008 has set up our economy for inflation, but the timing depends in part on how investors behave.

Last week I showed how the Federal Reserve dramatically expanded the monetary base (that is, the value of currency, coin and Federal Reserve deposits) at the end of 2008, and how nothing like this occurred during the onset of the Great Depression of the 1930s.

Still, even though monetary policy is so different in this recession as compared with the policies of the 1930s, inflation has not yet been very different.

During most of our lifetimes, there has been inflation: The prices of things we buy have generally increased over time. Only on rare occasions have consumer price trends suddenly changed directions.

One of those occasions was 1929.

Consumer prices were pretty constant in the 1920s. The chart below picks up the story in January 1929 with the red line. That line measures the (seasonally unadjusted) consumer price index in each month through July 1930, normalized so that October 1929 is 100 (for example, the value of 97.9 in April 1929 means that prices then were 2.1 percent lower than they would be in October).



In the fall of 1929, the inflation stopped (incidentally, the stock market crashed in late October of that year) and prices headed down, falling almost every month for almost four years.

For the first 15 months or so of this recession, consumer prices have followed a similar pattern. The blue series in the chart shows the consumer price index for 2008 and 2009. Like the 1929 series, the 2008 series is normalized so that October is 100.

The chart shows how consumer prices also rose in the spring and early summer of 2008. Inflation had stopped by the fall (there was a stock market crash in October 2008, too), and consumer prices headed down. In fact, the deflation at the end of 2008 brought prices down more than 4 percent in a couple of months, as compared with a 1 percent drop at the end of 1929.

The actions of the Federal Reserve and its chairman Ben S. Bernanke guarantee that we will not experience a four-year deflation like that of the Great Depression. But investor sentiment is an important reason why the short-run inflation patterns have been similar in 2008-’09 to what they were in 1929-’30.

During both episodes, investors had a sudden reduction in their willingness to hold private sector debt and equity and to purchase goods, and a sudden increase in their desire to hold “quality” assets like Treasury bills.

An increase in Treasury bill prices is one way markets adjust to this change in demand — and we saw this in September through December of last year — but another market adjustment is for the prices of goods, equities, and private sector debt to fall (or rise less than they would have) as investors pull their money out of these categories. Deflation is, by definition, a drop in goods prices.

Part of the next inflation may be the reverse of this process: Investors suddenly shift their demands from “quality” assets back to equities, private sector debt and goods. As some of the commenters explained last week, a sudden investor shift like this will be associated with a sharp reduction in the value of the dollar.

If I could predict exactly when investor demands will shift away from “quality” assets, both I and the readers of this blog might get as rich as the billionaire financier Warren E. Buffett. But recognizing the role of investor sentiment at least helps us appreciate why the timing of the next inflation is so uncertain.

17 comments:

Boomer said...

I tend to think of the fall in the value of the dollar as the inflation. When the supply of dollars exceeds demand, the value falls and the result will be a general rise in prices. Generally, these changes in trend with the dollar, because of its status as a reserve currency, are not sudden so you just need to watch the trend develop.

Having said that, there are a lot of ways to measure the value of the dollar so it isn't as easy as it sounds. I watch a lot of different markets (commodity indices, trade weighted dollar index, etc.) to identify the trend. You can also watch the TIPS market, but I'm not sure it will respond as quickly as commodities.

Right now, there is no trend. The dollar is basically the same price it was back in mid 2007. To really say the trend has resumed its downtrend, I think one would need to see gold over $1000 and the dollar index under 70. Just my two cents.

Yasir said...

property structures’ requirement would shift so much. Another participation of this document is to demonstrate how, even in the absence of financial make use of. bubblegum casting

Usama shaikh said...

Part of the next inflation may be the reverse of this process Investors suddenly shift their demands from quality assets back to equities private sector debt and goods bubblegum casting

JOJO said...

Property components are a naturally and considerably utilized claim on the value of property solutions because some of the payments. another link

Unknown said...

Since it develops in just 90 to 120 times, it needs less h2o and other information than sugarcane. Last year, Brazil generators placed Ceres lovely sorghum on more than 3,000 hectares. TUBE

JOJO said...

By the end of the novel, it is no more obvious who has being looking for whom, as both Winner and the Animal see themselves as sufferers of the other’s waste. Eventually, their connection is never resolved. Koerier Oosterhout

JOJO said...

We also discovered about Viega’s MegaPress System and each one of us pushed black tube. We also used a tube threads machine, so we could comprehend the different procedures available, and how long engaged when a specialist is on a job, threads tube. work from home

JOJO said...

Then, just last week, I went to Viega's training press occasion in Nashua, N.H. This was an excellent encounter to understand about Viega’s items and systems alternatives. We (members of the media) had an probability to install some of these alternatives in the academic facility. Asiapoker77

JOJO said...

Generally, these changes in trend with the dollar, because of its status as a reserve currency, are not sudden so you just need to watch the trend develop. the venus factor pdf

JOJO said...

Because we have not seen a recent drop in productivity, there is strong evidence that it's not the demand for products and workers that's down, rather it's the supply of workers that's down. That is, people want to work less. linked website

JOJO said...

It seems that the public takes to heart that everything Oprah(and others like her) say is the gospel truth. But they shouldn't !!! Much of what they say on their shows and in public are personal opinions. Steve Cooksey should have the same right as Oprah to offer his opinion. see this

JOJO said...

It’s great to come across a blog every once in a while that isn’t the same out of date rehashed material. Fantastic read! Andrew Heiberger

JOJO said...

In 2010 four NGOs published a detailed report indicating that Cameroon is one of the most hostile countries in Africa for LGBT people. to ask about the Antique Wine Company academy

JOJO said...
This comment has been removed by a blog administrator.
JOJO said...
This comment has been removed by a blog administrator.
JOJO said...
This comment has been removed by a blog administrator.
JOJO said...
This comment has been removed by a blog administrator.