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Freakishly low interest rates don’t get a break from U.S. and Canadian inflation

08/19/2011 by Alex Carrick, RCD Canadian Chief Economist

Now that many central bankers have committed to freakishly low interest rates for at least another year, they have to hope they will get a break with respect to inflation.

Unfortunately, the latest Consumer Price Index (CPI) numbers in both the U.S. and Canada don’t remove any of the concerns on that score.

The rate of overall price advance in the U.S. stayed at the same level in July as in the two previous months, +3.6%. The figure monetary authorities are hoping for – i.e., the target rate of inflation, whether formally stated, as in Canada, or left unstated, as in the U.S. – is about +2.0%.

History has proven that such a rate of price advance is favorable for an economy because it is neither too stimulatory nor restrictive.

An ongoing slight price advance raises at least the nominal value of major assets and makes people feel better about their holdings and finances. It also helps individuals and businesses pay back loans through income increases and the ability to charge higher prices for products.

The U.S. inflation rate in July exclusive of food and energy – otherwise known as the “core” rate – was +1.8%. While that is acceptable, the trend is something to keep an eye on.

The U.S. core rate of inflation has been shifting upward for seven straight months. 

Canada’s all-items inflation rate in July eased back to +2.7% from +3.1% in June. That’s good news, but don’t release the celebratory balloons just yet. July’s core inflation rate moved up to +1.6% from +1.3% the month before.

In July, gasoline prices in the U.S. eased back slightly to +33.6% year over year from +35.6% in June. Drivers in Canada also saw the year-over-year change in prices at the pump trend down, from +28.5% in June to +23.5% in July

The overall mix of economic indicators has turned decidedly less robust. Debt problems and lower output in Europe are limiting prospects there. The appreciation of the yen in Japan will diminish some of the stimulus benefits to come from post-tsunami rebuilding efforts.

China will continue to grow with vigor, but perhaps not as strongly as in the past as Beijing raises rates and restricts credit to slow down a rate of price increase that has become too rapid.

Backing up for a second, the appreciation in the value of the yen and another major currency, the Swiss franc, is the result of one specific occurrence that has shifted the outlook more than any other in the last couple of weeks.

What I’m talking about, of course, is the downgrade of U.S. debt from Triple A to the next highest ranking (AA+).

The action on U.S. debt is a reflection of the fact that, to the world at large, the U.S. appears to have become almost ungovernable. The down-to-the-wire debate to raise the debt ceiling was an unbecoming spectacle.  

Rancor, rigidity, positions held strictly on party lines, points made only to further political ends and ideologies taken to extremes are all ways to characterize what is now taking place in Washington on a regular basis.  

Traditional economic theory holds that the early fragile stages of an economic recovery are not the time to adopt overly restrictive fiscal policies. Hold off until growth has taken deeper root and the economy can better withstand a reduced government presence.

Or if it is judged that debt has become such a problem it absolutely must be addressed right now, don’t tie the hands of policy makers by removing the full range of tools that might be employed to fix things. That means stepping away from balanced budget amendments and being open to tax adjustment measures.

There is one other factor common to the age we live in that may be making matters worse rather than helping. What I’m speaking of is the modern proclivity to try to fix all problems.

With respect to economic recoveries, what happened in the past may not have always worked perfectly smoothly, but those days are starting to look pretty good compared to what we’re witnessing now.

At any given time, there is an overall sense of health associated with the economic outlook, running the gamut from ill to glowing and largely fostered by the media. In the last three weeks, that prevailing mood has taken a downturn from guarded optimism to being on the cusp of negative.

If the U.S. collective psychology doesn’t soon receive a dose of better medicine, we may simply have to take our lumps while moving to an understanding. Both good and bad cycles come and go, but the unpleasant one we’re currently experiencing may be a particularly protracted one.

Canada inflation – all items CPI vs CORE*
(not seasonally adjusted)
Canada  inflation – all items CPI vs CORE
In Canada, the change in the energy sub-component index was +12.9% year over year in July 2011.

The Canada figure (CPI) is the All Items Consumer Price Index. *Core inflation has been defined by the Bank of Canada. It is the Consumer Price Index (CPI) excluding the eight most volatile components: fruit, vegetables, gasoline, fuel oil, natural gas, intercity transportation, tobacco and mortgage interest costs. It also excludes the effect of changes in indirect taxes on remaining items. The core inflation rate in Canada is monitored with respect to setting interest rate policy. The target range is 1% to 3%.
Data source: Statistics Canada.
Chart: Reed Construction Data - CanaData.
U.S. inflation: all items (CPI-U) vs all items less food and energy
(not seasonally adjusted)
U.S. inflation: all items (CPI-U) vs all items less food and energy
In the U.S., the change in the energy sub-component index was +19.0% year over year in July 2011.

The U.S. figure (CPI-U) is the All Items Consumer Price Index for All Urban Consumers.
Data source: U.S. Bureau of Labor Statistics (Department of Labor).
Chart: Reed Construction Data - CanaData.

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