Inflation verses relative price changes

It is starting to look like the cyclical bottom in inflation may be at hand. But there is much confusion over current price changes. There are two types of price changes to consider. One is the change in relative prices. The other is the change in the overall price level, or inflation. Currently we are seeing large change in relative prices, but little change in the overall price level, or inflation.

From their 2008 peak the CRB for foodstuffs fell from 525 to 330 and has since rebounded to 609. So it is now 16% above its 2008 peak.

Over the same period the CRB for industrial raw materials fell from 427 to 286 and rebounded to 464, an 8% gain, while oil fell from $133 to$40 and rebounded back to $90.

But the deflator for personal consumption expenditures is now at 111.6 versus its’ 2008 peak of 110.9. The later is a measure of the overall price level, or inflation, while the swings in commodity prices measure changes in relative prices, not inflation.

Part of the reason that inflation and swings in raw material prices are two very different things is that raw material prices are such a small portion of final costs and big changes in raw material cost have little impact on final prices.

Over the past year semiconductor prices fell about 15% while cotton prices rose 115%. These are changes in relative prices, not inflation. The Fed is no more responsible for the rise in cotton prices than it is responsible for the fall in semiconductor prices. In 2010, nominal GDP rose 4.2% and the GDP deflator was up about 1%. Over the same time, M 1 rose 6.5% and MZM was up about 2%. This is what you can hold the Fed responsible for, not the change in relative commodity prices.

Moreover, labor compensation only rose about 1.5% and unit labor cost for nonfarm business is still falling. As long as these factors are this weak, I will not worry too much about inflation.

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