Relevant and even prescient commentary on news, politics and the economy.

Fowl and Fishy Inflation

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.

 Graph 1 YoY Price increases for Selected Food Stuffs and All Items Less Food and Energy

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.

Graph 2 YoY Price increases for Selected Food Stuffs with Avgs and All Items Less Food and Energy

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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Transmission Channels for the Fed’s QE2

What are the channels for QE2? In a recent post, David Beckworth outlines his frustration:

It has been frustrating to watch Fed officials explain QE2. The standard Fed story centers around the QE2 driving down long-term interest rates and stimulating more borrowing.

On the tip of my tongue, I can think of three direct channels: (1) the interest rate channel, which is the source of his frustration, (2) the wealth effect channel, and (3) the weak-dollar channel.

  1. The interest rate channel: the Fed lowers current and expected real borrowing costs to firms and households, thereby stimulating domestic demand via increased consumption and investment. Clearly, this is the most clogged channel, as it requires increased bank lending and leverage build.
  2. The wealth effect channel: the Fed drives up the price of riskless assets (bonds), forcing substitution toward risky assets (equities, corporate bonds, etc.), which raises household wealth (via asset price appreciation) and current consumption demand. This channel was highlighted publicly in October by Brian Sack at the 2010 CFA Fixed Income Management Conference:”Nevertheless, balance sheet policy can still lower longer-term borrowing costs for many households and businesses, and it adds to household wealth by keeping asset prices higher than they otherwise would be.” In my view (see chart below), this has been the strongest channel through which Fed policy has worked.
  3. The weak-dollar channel: the Fed prints money, thereby debasing the currency relative to global trading partners. The technicalities of a weak dollar policy prevent the Fed’s actions as directly being a weak-dollar policy; however, the short-term effect on the dollar was quite strong. In the end, though, we see that the Fed’s policy has had no accumulated impact on the dollar to date (see chart below). This policy still has some time to work through, since the Fed only recently initiated its quantitative easing program again. Furthermore, it’s unclear to me how the dollar will play out in 2011 (perhaps another post), since it’s really a relative game: Fed QE versus the European debt crisis, EM inflation expectations rising, or the like.

The chart below proxies the three channels using the 5y-5yr forward TIPS rate (1), the S&P 500 equity index (2), and the dollar spot index (3). The value of each channel is indexed to the September FOMC meeting for comparability.

The interest rate channel has been negative, as expected real yields increased 35% since the FOMC meeting, driving up expected borrowing costs. The wealth channel has been strong and positive. The S&P 500 gained 9% since the September FOMC meeting date, but the gains really started earlier, as speculators front-ran the Fed decision. Finally, the dollar channel fizzled out, as the dollar index (against major trading partners) is pretty much flat over the period.

I’d like to hear your input regarding other potential channels for Fed policy. But the data has, objectively, been surprising to the upside. Thus the growth outlook has improved. The chart below illustrates the Citigroup economic news surprise index (compared to Bloomberg consensus), which turned to the positive at the outset of November.

Many moving parts.

Rebecca Wilder

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