From Steve Randy Waldman’s Interfluidity current post:

Scott Sumner responds.

Related — elsewhere:

• Tyler Cowen — Why are the high growth countries so often the high inflation countries?
• Kevin Erdmann — 1970s vs. 2000s: Gender Effect
• Edward Lambert — Has the Fed rate done a good job to balance inflation over the years?
• Edward Lambert — An Effective Demand look at the inflation of the 1970′s
• Edward Lambert — Will there be an inflation in the next recession?
• Marcus Nunes — The Origins of the “Great Inflation”
• Marcus Nunes — Eureka! The Great Inflation was the result of demographic trends
• Steve Roth — Did the Baby Boom Labor Force Surge Cause The Great Inflation?
• Steve Roth — More on the Labor Force Surge and 70s Stagflation
• Mike Sax — Sumner vs. Waldman on the Great Inflation: Was it a Monetary Phenomenon
• Kark Smith — Everything You Thought You Knew About The 1970s, Inflation And The US Economy Is Wrong
• Kark Smith — Inflation And The Baby Boom
• Kark Smith — The Audacity of High Inflation
• Evan Soltas — Were Crowded Discos Inflationary?
• Scott Sumner — Yes, expansionary monetary policy really did cause the 1970s inflation.
• Scott Sumner — Why causality matters

Related — here:

• Not a monetary phenomenon
• Demographics and inflation: international graphs

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Vis Brad Delong’s post on CORRECT PREDICTIONS AND THE STATUS OF ECONOMISTS

Paul Krugman is certainly right that history has judged, and that the judgment of history is for James Tobin over Milton Friedman so completely that there is not even a smudge left where Friedman’s approach to a monetary theory of nominal income determination once stood.

And Robert Walmann points out, repeatedly and correctly, that there is nothing theoretically in Friedman (1967) that is not in Samuelson and Solow (1960)–that inflation above expectations might deanchor future inflation was not something Friedman (or Phelps) thought up, and that neither Friedman (nor Phelps) was thinking that high unemployment might deanchor the NAIRU.

comes Angry Bear Robert Waldmann’s reply to a comment, worth reading with care:

“the vertical long-run Phillips Curve of Friedman (and Phelps) is simply wrong at low rates of inflation” But above very low rates of inflation, say 2%, it it essentially correct and therefore a very useful first approximation. (Full Employment Hawk)

Robert Waldmann replied:

By “very correct” you mean “corresponds to post WWII US data because all the other evidence is long ago or far away and irrelevant”. The vertical long run Phillips Curve of Friedman (and Phelps) was a terrible approximation to European data from 70 something through now. Europe has not been in a liquidity trap all those decades. Now if “long run” is defined as “a milenium” then we Blanchard and Summers (1986) didn’t prove Friedman (and Phelps) wrong. This is because “long run” can be a metaphysical un falsifiable claim if the long run is longer than any time series. It is in this sense and in this sense only that Friedman hadn’t been proven wrong already by 1990.

Also Friedman’s most powerful devoted follower (and most devoted powerful follower) provided incredibly strong evidence that he was just totally full of it. In 1985 the border of the European unemployment problem was the Atlantic Ocean. The contrast between the UK and the US was extreme. Then the stock market crashed in 1987. Thatcher feared a repeat of the great inflation. This (unlike persistently hign unemployment) struck her as worse even than inflation. So she pumped up the money supply (the BOE was not indenpendent back then). This caused an inflationary boom. UK economists discussed how firms had trouble filling vancancies. There was a mystery as the Beveridge curve shifted with high vacancies and high unemployment (a total mystery to people who hadn’t heard of the matching function). Then UK unemployment fell and stayed low. Expansionary monetary policy was followed by persistently lower unemployment (and a bit of inflation which didn’t persist). There could be no stronger test of Friedman’s theory which I now consider total crap because, according to an equally valid theory, I have too high a level of green bile and too little Phlegm.

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It’s history lesson time again.

In 1993, Bill Clinton enacted an economic program centered around some public investment, coupled with deficit reduction with higher taxes on the rich. Boskin was very, very sure it would fail. In a Journal op-ed entered into the Congressional Record by grateful Republicans, he accused Clinton’s administration of “fundamental distrust of free enterprise.” He made a series of predictions: “The new spending programs will grow more than projected, revenue growth will be disappointing, the economy will slow, and the program will reduce the deficit much less than expected.”

Boskin repeated his prophecies of doom in a summerlong media blitz. Boskin labeled Clinton’s plan “clearly contractionary,” insisted the projected revenue would only raise 30 percent as much as forecast by dampening the incentive of the rich, insisted it would “take an economy that might have grown at 3 or 4 percent and cause it to grow more slowly,” and insisted anybody who believed in it would “Flunk Economics 101.”

In the early 1990s, Senator Patrick Moynihan from New York warned his fellow legislators about rising social security commitments. Then the worm crawled out of his hole, so to speak. Federal Reserve Chairman Alan Greenspan testified before the Senate and House Budget Committee on January 10, 1995. He told the Committee the inflation rate was probably overestimated by 0.5% to 1.5%.

If Greenspan was correct, this was a godsend. Social security payments are increased each year at an inflation rate calculated by the federal government: the change in the Consumer Price Index (CPI). If the CPI could be increased at a lower rate in the future, benefits would rise more slowly, without Congressional action. This would reduce government spending and delight politicians, who knew of the looming crisis in social security but did not want to imperil their careers by reducing benefits, or, in this case, by cutting the rate at which social security benefits were raised each year.

The Boskin Commission was duly formed. Michael Boskin was the right man for the job. He had served as chairman of the President’s Council of Economic Advisers (CEA) from 1989 to 1993, a post previously held by such government functionaries as Arthur Burns and Alan Greenspan.

The commission is itself a delicious example of such bias: All its members were on record prior to the establishment of the commission as believing the CPI to be overstated. At the same time, the commission took no evidence from such well-known economists as Janet Norwood, a former head of the Bureau of Labor Statistics, and Dean Baker, of the Economic Policy Institute, who believe that the CPI provides a reasonable reading of inflation. In effect, the commission took account of all the evidence of overstatement of inflation by the CPI and downplayed the evidence of potential understatement.

If cost-of-living inflation has been overstated, then the growth of the economy and real wages has been much higher than previously reported. The commission has thus solved the problem of stagnating wages, which is now revealed to be a mere fiction. Far from experiencing a “silent depression,” the commission implicitly claims, American families have never had it so good.

If inflation, wages, and income have all been misstated, years of research have been conducted using incorrect data. Thus much of this research, which purportedly confirmed the profession’s theoretical claims, is no longer valid.

Lowering the CPI inflation rate would therefore affect income-tax exemptions and push many middle-class families into higher tax brackets. Adopting the Boskin Commission’s findings would be tantamount to imposing a tax hike that would particularly affect lower- and middle-income families.

Both Democrats and Republicans have been keen to see its recommendations adopted, because they provide a potentially uncontroversial way to achieve deficit reduction. Raising taxes is unpopular, and little discretionary government spending is left to be cut. Restating the CPI as a measure of cost-of-living inflation offers an easy way to lower Social Security payments through reduced COLAs and raise tax revenues through reduced exemptions. The hope is that the CPI can be presented as an apolitical and boring technical issue that voters won’t notice.

Revising the CPI would get the Republicans off the hook of deficit reduction, while simultaneously advancing the interests of business. This, however, would occur at the expense of working Americans and the elderly. Revising the CPI would get the Democrats off the same hook, but at the cost of another shameful desertion of the constituencies they claim to represent.

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by reader Matthew McCosker

I can credit two sources that have shaped my thinking on both economics, politics (I am quite apolitical these days), and finance. One is the Angry Bear blog, and the second is Warren Mosler.
On the bus this morning, I was glued to a post at Warren Mosler’s blog, where he responds to a David Stockman oped in the New York times:

The Stockman’s Big Swinging Whip 
 
 http://moslereconomics.com/2013/04/01/the-stockmans-big-swinging-whip/

The Stockman piece along with Warren’s commentary paints quite a picture, and spans quite a bit of economic history. In some places he agrees, but many he does not. Here Stockman appears to blame the state’s interference in free markets, and Warren correctly notes that the “free” market is completely dependent on a simple, but important product produced by the government – our currency, which is not created by the “free” market at all, the free market is a user only:

[Stockman] Instead, America will descend into an era of zero-sum austerity and virulent political conflict, extinguishing even today’s feeble remnants of economic growth.

This dyspeptic prospect results from the fact that we are now state-wrecked. With only brief interruptions, we’ve had eight decades of increasingly frenetic fiscal and monetary policy activism intended to counter the cyclical bumps and grinds of the free market and its purported tendency to under produce jobs and economic output. The toll has been heavy.

[Mosler] The currency itself is a simply public monopoly, and the restriction of supply by a monopolist as previously described, is, in this case the cause of unemployment and excess capacity in general.
A particular area of interest for me has been the inflation of the Seventies. Mostly, because it has become American economic folklore akin to Weimar or Zimbabwe inflation, where Volcker the dragon slayer stepped in to stop it. I am not totally convinced of this storyline. For example, one observation is why does inflation appears to track the Fed Funds rate quite closely during the decade, and then diverges in the early 80’s, and then seems to track more closely again (see both FRED charts. So the lower the Fed Funds rate the lower the CPI? Were Volcker’s hikes even necessary? It is no coincidence that oil prices started going up when the Texas Railroad Commissioner began to lose control over the price they set for oil (yes oil prices were regulated for a long time prior to the 70’s and the TRC was OPEC before there was OPEC), and foreign embargos caused price shocks. Warren has a few exchanges around inflation in his piece, but oil prices being the main culprit in the 70’s:

[Stockman]  The Fed, which celebrates its centenary this year, fueled a roaring inflation in goods and commodities during the 1970s that was brought under control only by the iron resolve of Paul A. Volcker, its chairman from 1979 to 1987.

[Mosler ]It was the Saudis hiking price, not the Fed. Note that similar ‘inflation’ hit every nation in the world, regardless of ‘monetary policy’. And it ended a few years after president Carter deregulated natural gas in 1978, which resulted in electric utilities switching out of oil to natural gas, and even OPEC’s cutting of 15 million barrels per day of production failing to stop the collapse of oil prices.
Quantitative easing, which seems to be the most misunderstood and feared operation being conducted by the Fed is covered with the following exchange:

[Stockman] Since the S.&P. 500 first reached its current level, in March 2000, the mad money printers at the Federal Reserve have expanded their balance sheet sixfold (to $3.2 trillion from $500 billion).
[Mosler] And also debited/reduced/removed an equal amount of $US from Fed securities accounts. The net ‘dollar printing’ is 0.

[Stockman] Yet during that stretch, economic output has grown by an average of 1.7 percent a year (the slowest since the Civil War); real business investment has crawled forward at only 0.8 percent per year; and the payroll job count has crept up at a negligible 0.1 percent annually. Real median family income growth has dropped 8 percent, and the number of full-time middle class jobs, 6 percent. The real net worth of the “bottom” 90 percent has dropped by one-fourth. The number of food stamp and disability aid recipients has more than doubled, to 59 million, about one in five Americans.

[Mosler] Yes, and anyone who understood monetary operations knows exactly why QE did not add to sales/output/employment, as explained above.

The piece ends with agreement on banking regulation:

[Stockman] It would also require purging the corrosive financialization that has turned the economy into a giant casino since the 1970s. This would mean putting the great Wall Street banks out in the cold to compete as at-risk free enterprises, without access to cheap Fed loans or deposit insurance. Banks would be able to take deposits and make commercial loans, but be banned from trading, underwriting and money management in all its forms.

[Mosler] I happen to fully agree with narrow banking, as per my proposals.

You can read Warrens banking proposal here: http://moslereconomics.com/wp-content/pdfs/Proposals.pdf
 
In the end, there seem to be plenty of policy options. Unfortunately, there is a digging in of political heels
The Stockman piece is here:
Sundown in America
http://www.nytimes.com/2013/03/31/opinion/sunday/sundown-in-america.html?src=me&ref=general

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It has been suggested that the rapid increase in the prices of fish, fowl, meat and eggs for about two years following October, 2009 was the result of QE causing inflation in these items.  From this Calculated Risk graph, we can get the QE date line.  QE was announced on Nov 25, 2008, and expanded in April 2009.  It ended in May, 2010.  QE II was hinted at in Sept, 2010, announced in Nov 2010, and ended in August 2011.

The timing correspondence is less than stellar, since the YoY increase in prices for those food items dropped like a rock from October, ’08 though Oct. ’09.  It then shot up to a 7 1/2 year high in May of 2011.

This can be seen in the red line of Graph 1, which also shows the CPI for all items except food and energy (CPILFESL) in blue.

To assume a cause and effect relationship, you have to account for a time lag of a year from the announcement and 6 months from the expansion of QE to the turn around in those price increases from the Oct ’09 bottom.  Remember, through the first 11 months of QE, the YoY change in those prices dropped dramatically.  Between May and November, 2010, while no QE program was in effect, these prices had the steepest part of their rise.  After QE II ended in August, 2011, the YoY price increase remained high for those items until the end of the year, and then fell rapidly.

A longer view reveals that the increase in those food prices oscillates continuously around the All Items Less Food and Energy line.  The trough to trough period is irregular, averaging 3.52 years with a standard deviation of 0.45 year (5 measurements).   The trough to trough time from May, ’06 to Oct., ’09 was a very typical 3.4 years.  It is very hard to look at that graph and see anything unusual about the 2008-2012 region, other than the depth of the trough shortly after the Great Recession.

It appeared to me that the blue line of Graph 1 might be a crude approximation of a long average of the red line.  This turns out not quite to be the case, since the two lines are measuring different baskets of goods.  What we have is the YoY increase for these food items oscillating around its own mean. That sounds like a tautology, but let’s look a little deeper.

Graph 2 shows the same data, along with some long averages of the food stuffs YoY price increase line.   These are the 5 Yr (light blue), 8 Yr (yellow), and 13 Yr (purple) moving averages, and the average for the whole data set, 2.9 (bright green).  I’ve also included an envelope one standard deviation (3.06) above (5.96) and below (-0.17) the mean in dark green.

This (sort of) resembles a control chart.  The +/- Std. Dev. envelope isn’t a hard barrier, but does tend to turn the data path back toward the mean, unless something strange happens.  Frex, the big rise from late ’02 to early ’04 followed the Iraq invasion and resulting disruption in petroleum pricing.  The ’09 trough was the result of the Great Recession.  These are explainable variations.

Note also that the moving average lines tended to run below the CPILFESL line prior to late 2002, and have tended to run above it since.  This is to be expected since these items are basically the top of the food chain and have several layers of fuel dependent contributors in their cost structure.  Recall that until 2002, fuel prices were low, and since then (except for the Great Recession) have increased steadily.

I’m quite sympathetic to the idea that QE has done very little to help ease the economic doldrums following the GR.  But I see no reason at all to believe that it has contributed to the pain and suffering of ordinary citizens at either the grocery store or the gas pump.

Maybe there have been real downsides to QE.  Any thoughts on what they might be and how to quantify them?

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by Rebecca Wilder

Euro Area Inflation: A Very Slow Burn

Euro area consumer prices increased at a 2.4% annual pace in May, down 0.2 ppt from the 2.6% pace in April. Core inflation fell to 1.8% in May from 1.9% in April. Headline and core inflation peaked in the fourth quarter of 2011, and disinflation is underway.

Euro area price inflation is burning out but at a very slow pace.

The 0.6 ppt differential between headline and core inflation is explained by energy and unprocessed food prices. In May, the energy component in HICP (harmonized index of consumer prices) fell 1.4% over the month and posted a 7.3% pace compared to May 2011. Energy prices peaked in April 2012, but base effects will prop up headline inflation through early 2013 even if energy prices go unchanged over the near term. That means headline inflation could be sticky for some time above 2%. But core inflation is not.

President Draghi often speaks of the upward pressure on inflation stemming from tax hikes across the various fiscal austerity programs. Stripping out the tax effects (this data is provided by Eurostat), the theoretical inflation rates in Portugal and Italy are 1.8ppt and 0.8ppt, respectively, below the headline rate. The downward pressure on inflation may quicken through next year, as the effects of VAT and various tax hikes wear off across the region…barring a miraculously robust economic recovery, of course.

(Note: In the chart below, the black line represents 0% difference between headline inflation and tax-adjusted inflation. For orange triangles above the black line, headline inflation is above tax-adjusted inflation, i.e., taxes are boosting aggregate prices.)

Inflation takes time to build, so this disinflationary trend is unlikely to change anytime soon without significant policy accommodation.


Rebecca Wilder

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At Illusion of Prosperity, Stagflationary Mark posted this scatter-graph of quarterly GDP YoY growth and CPI data from Q1, 1948 through Q4, 2011.  Each point represents the differences from the medians of each data set for each of the variables, respectively.  This gives you a picture of time spent above and below what might be considered normal performance.

I wondered how this would look if each point were identified by presidential administration, and if this would suggest any particular narrative.  So I redid the graph, data from FRED, using mean instead of median as the determinant.  It is presented here as Graph 1, with each data point (256 total) color-coded by presidential party; red for Republicans, blue for Democrats.  The calendar quarter of each president’s inauguration is allotted to the previous administration.

I’ve labeled the quadrants as follows, and indicated the frequency of data points populating each quadrant.

Here are the Mean and Standard Deviation values.

 

The GDP data has something close to a normal distribution, with approximate symmetry around the mean. The CPI data does not. For CPI, the highest frequency is 2 percentage points below the mean, and there is a long tail on the high side, so the distribution looks more like a Poisson type.

I’ve broken out presidential administrations, 3 or 4 to a graph, to avoid excessive clutter.  Graph 2 shows the administrations of Truman (light blue), Eisenhower (red), and Kennedy-Johnson (dark blue.)

Results during the Truman administration were erratic, with both inflation and deflation occurring, and GDP growth widely variable as the nation made post WW II adjustments, and several million G.I.’s reentered the work force.  Ike was an inflation hawk, and one of only two presidents to achieve below average inflation in every quarter of his administration.  (Take your guess now as to who the other might be.  All will be revealed in due time.)  Still, the road was bumpy, with GDP growth highly variable, and two rather severe recessions during his term.  The Kennedy-Johnson administration enjoyed superior economic performance and relatively low inflation, with only 6 quarters of below average GDP growth, and only five quarters of above average inflation during the entire 8 years.  This was one of only two administrations to avoid recession for an entire 8-year term.

Graph 3 shows the Nixon-Ford (orange), Carter (blue), and Reagan (red) administrations.

Here we find three increasingly extreme excursions into stagflationary territory, two under Nixon-Ford (remember Whip Inflation Now buttons?) and one under Carter. The first and mildest was in 1970, the second in 1974-5, and the last, in 1979-80 probably played a part in holding Carter to a single term.  Inflation far above average plagued both of those administrations.  Each spent time above and below average in GDP growth with term averages very close to the grand average.  However, Carter’s last two years were consistently below average, and coupled with high inflation, earning him his moribund reputation.  Early in Reagan’s first term, Volker finished slaying the inflation dragon.  But the cost was high in terms of depressed GDP growth, and during that time Reagan was extremely unpopular.  But, as the economy recovered, so did his reputation, and he is now remembered, for good or for ill, as one of America’s most beloved presidents.  The remainder of his presidency resided along at least one of the two average lines, including four consecutive quarters of exceptional GDP growth coupled with only slightly above average inflation, spanning 1983-4.

Graph 4 shows the Bush Sr. (orange), Clinton (light blue), Bush Jr.(red), and Obama (dark blue) administrations.

During the Bush Sr. administration, 11 of 16 quarters had below average GDP growth, 10 quarters had above average inflation, 8 of these quarters had both.  Clinton’s term began and ended with below average GDP growth, but during his 8 years here were only 9 below average quarters.  Four of them occurred in sequence from Q2, 1995 to Q1, 1996, but the remainder of 1996 was quite strong, and Clinton was granted a second term. Clinton was both the other president who avoided having even a single quarter of above average inflation, and the other president who avoided having a recession during an entire 8-year term.  During the 8-year term of Bush Jr. there were only 4 quarters of only slightly above average GDP growth, occurring from 2003 to 2005.  There were 7 quarters of above average inflation, 3 of them just barely so in 2005-6, and the other 4 in 2007-8, just prior to the economic collapse.  The remainder of his term was in the mild doldrums region.  The collapse ushered in the Obama administration.  Within his first year, the economy was back into the mild doldrums area that has so far been typical of the current century. 

Here is one more graph, showing how each administration performed, as an average over its entire term.  Starting with Truman, the yellow line leads us to each successive administration, up to Obama.

Obama’s position suffers from the recession he inherited.  Whether he gets reelected or not, his average will move up each remaining quarter of his presidency.  If he gets a second term, we can expect more of the doldrums we have experienced over the last two years.

This clearly belies the Romney claim that Obama’s economic policies have failed.  His policies have moved us from near-depression to mere mediocrity.  That counts as some sort of success.

So, here is my narrative.  First off, one can argue that the president does not directly determine the economic fate of the country, and that is partly true.  The other part is that the president sets the policy and the tone, and that both of these things matter.

–  The only presidents to have achieved term averages in the prosperity quadrant were Democrats.
–  The only Republican to achieve above average real GDP growth was Reagan, and that was only by an increment.
–  The only president since Reagan to achieve higher GDP growth than his predecessor was Clinton, other than that, it’s been a downward spiral.
–   Carter had below average GDP growth by a slight margin, but he beat every Republican other than Reagan, and he didn’t trail him by much.
– The last 44 years have been characterized by secular decreases in both CPI inflation and GDP growth.
– They have also been characterized by Republican presidencies 64% of the time, decreasing regulation, lowered tax rates, safety net erosion, loss of labor union strength and participation, and the systematic undoing of of New Deal policies.

What I conclude is that New Deal (dare I say Keynesian?) policies were successful in generating real prosperity, and free market policies have been far less successful.  Over time, Reaganomic trickle-down, free market policies have given us first, the Great Stagnation, and ultimately the worst economic crisis in 80 years.  These policies were, by no coincidence at all, quite similar to those in effect when the Great Depression of the 30’s happened – and also all the other earlier depressions that are no longer very prominent in people’s memories.

As I said, policy matters – and it matters profoundly.

With that in mind, here is my question to the Fed:  Since the average of CPI inflation since WW II is 3.7%, and there is ample evidence that we can have very reasonable economic performance with inflation in that range, why have you set an inflation target that is effectively half of that level, while ignoring high unemployment –  the other half of your alleged dual mandate?

Of course, I’m being rhetorical.  It’s because they are bankers, and inflation favors creditors borrowers, not lenders.  The fact is they don’t care one whit about unemployment.

Policy.

It matters.

Cross-posted at Retirement Blues.

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by Rebecca Wilder

Lieblings quote of the day by Dean Baker:

“The ECB is run by a perverse cult that worships 2.0 percent inflation and is prepared to sacrifice almost all other economic goals to meet this target.”

The article goes on to argue that the ECB should increase its inflation target to 3-4% in order to facilitate positive wage growth in the debt deflationary economies like Spain. I’ve argued a similar point in the past.

However, I’d like to add that this “perverse cult” called the European Central Bank (ECB) raised its policy rate on April 13 – a point in time that correlates perfectly with a shift in trend across euro-area bond markets. Specifically, April 13 marks the upswing in risk premia on Italian, Spanish, and Belgian bonds relative to German bunds. Hmmm…policy mistake?

Now that’s just malicious.

Rebecca Wilder also posted at Newsneconomics

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by Mike Kimel

Howard Hill on has been arguing with gold bugs:

I know that some readers are going to say “Wait. The gold market is saying inflation, not deflation.”

That’s not how I see it. I see the negative real rate on cash parked in T-bills (three month yield 0%, 12 month yield 0.08%) as a clear indication that prices are going down, not up. As more and more market participants equate gold to another currency, they are simply diversifying their cash into that currency along with Dollars, Pounds, Swiss Francs, Yen and Euros. If you consider the total bullion supply, the allocation into gold is less than $10 trillion worldwide, a small fraction of the total debt held as investment.

The key to understanding the mixed signals of gold and the bond market(s) is to realize that boiling every bit of information in the market down to a single price eliminates much of the information. Once that information is reduced to a single data point, you can’t actually re-create it. We’re left guessing at what forces are at work that put the prices where they are.

The one thing that makes no sense is to look at one market (eg gold) and conclude that there is inflation ahead while ignoring other larger markets that are telling the opposite story.

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Today Eurostat released April 2011 inflation for the Euro area. Prices are increasing at a 2.8% annual pace, up from 2.7% in March and very much above the ECB’s comfort zone of around but slightly below 2%.

Today’s report is the second release and includes the cross section of price gains below the headline number. The first ‘flash’ estimate does not specify the breakdown.

Inflation’s hitting all sectors, goods (primarily) and services alike, via inputs to production.

READ MORE AFTER THE JUMP!April core prices rose 1.6% over the year. The goods-price inflation is flowing into the the service-sector as well – headline service-sector inflation is 2.0% in April, up from its low of 1.2% one year ago. There may be some seasonal distortions here associated with the Easter holiday, but the upward momentum has been established.

Price gains at the country level are broad based.

2% annual inflation is increasingly ubiquitous for key countries, Periphery and Core core alike. Below is the diffusion of 2% annual price gains, where an index value above 50 indicates that the majority of component prices are rising at a 2% rate. The legend indicates the longer-term average diffusion of price gains.

Germany is still seeing the majority of annual price gains below 2% – the current index is 43 – but the breadth of 2% inflation is increasing beyond its longer-term average of 34.8. In Spain and Italy, current inflation diffusion indices are likewise increasing, where Spanish price gains are broad, 55.6 in April.

And it’s not just VAT taxes.

The chart below illustrates the tax-adjusted inflation rate across the Eurozone (ex Ireland, unfortunately, whose data is unavailable, Austria, Estonia and Cyprus). This series is lagged one month.

The tax-adjusted inflation rate assumes that all tax hikes are passed fully through to final goods prices. It gives a proxy for the inflation effect of fiscal austerity (hike in VAT, for example).

Although the uptick in inflation is warranted at this stage in the recovery, especially in the core, the momentum in prices can no longer be attributed to taxes only – it’s broader than that. Greece, for example, saw its inflation rate peak around 5.6% in September 2010 when its tax-adjusted inflation rate (inflation excluding VAT) was just 1.1%. Now, however, the headline and tax-adjusted inflation rates are converging, 4.5% vs 1.7% in March. Much of the tax-adjusted inflation can be attributed to food and energy; nevertheless, the base effects of the VAT hikes are wearing off.

Tricky times for Euro area policy makers when the Core AND the Periphery are showing such broad price gains. Meanwhile, the Periphery are contributing little by way of growth.

Rebecca Wilder

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