Inflation risk

Alberto Cavallo writes,

By April 2020, the annual inflation rate of the US Covid index was 1.06%, compared to only 0.35% of the equivalent CPI (all-items, US city average, not seasonally adjusted). The difference is significant and growing over time, as new social-distancing rules and preferences prevent consumer spending in categories that are experiencing deflation, such as transportation, and induce more expenditure in food and other groceries, where prices are increasing over time.

This is one reason that TIPS or other inflation-indexed bonds may not hedge well against inflation. Official measures may not pick up the rise in the cost of living.

13 thoughts on “Inflation risk

  1. Alberto Cavallo is comparing the current economy to a GDP factory model and needs a positive definite bell curve consumer index when doing so.

    He is implementing the definition of a stable GDP factory. In the model the consumers are all independent arrivals at the retail outlets. It is as if we had already equilibriated via divine intervention.

  2. From the Zombie companies article:

    “Zombies” are firms whose debt servicing costs are higher than their profits but are kept alive by relentless borrowing.

    “This is a macroeconomic problem because zombie firms are less productive, and their existence lowers investment in and employment at more productive firms,”

    In terms of real, rather than nominal economic output is this a real distinction?

    Suppose a zombie firm, let’s call it American Airlines. Its profits are way down, but it’s continually rolling over its debt at low rates so it doesn’t go bankrupt.

    The output, in real terms, is whatever X number of trips it sells.

    Now, suppose the same situation, but high interest rates force AA to liquidate. Its stock of planes is bought up by a new startup airline… Pan Am, for pennies on the dollar, and most of its employees are hired back to service the same routes and sell the same X trips that American sold before.

    In terms of real output, it’s basically unchanged. Employment is slightly reduced. Wealth, as measured in the accumulated capital stock, has been reduced because the debt instruments that were attached to American are caput and the planes are now revalued at lower prices.

    In the process, the owners of American are now poorer and the owners of Pan Am is now richer, but fundamentally nothing seems changed except how the losses are accounted for.

    In the Zombie situation, there’s a chance for the company to regain profitability and proceed without destroying everyone’s balance sheets, but a risk that people’s balance sheets are slowly eroded.

    In the bankruptcy situation, there’s a chance that some folks make a windfall (by buying cheap and then raking in the profits in the future) and that the newly unemployed who have been “freed” (in a truly Orwellian use of the word) from their jobs at the Zombie firms may be employed more productively. On the other hand, there’s the chance they may not, and the likelihood that many of the balance sheet losses become more than paper losses and affect a lot of real stuff (imagine this as the formerly productive capital stock of airplanes rotting and falling apart if not maintained).

  3. A 1% annual inflation rate still seems very low, and is lower than CPI inflation for 2019. One way or another the pandemic crisis is going to be over by the end of 2022. I guess I am failing to see how the real factors of production, or the things that people want to buy, or how businesses are organized, are going to be all that different in 2023 than they were in 2019. We can already see that people still want to eat out at restaurants, even as cases are rising. By 2023 we are either going to have herd immunity or an effective treatment, or both. So why won’t people just more or less resume what they were doing in 2019, with only a few changes around the margins?

  4. 40% of food price inflation is apparently in meat prices. Meat prices seem to be a one-off combination of a temporary supply shortages from temporary plant shutdowns and a related rush to fill freezers. I will predict eventual deflation of meat prices. Toilet paper and hand sanitizer prices also soared but have been deflating recently as supply begins to increase.

    Printing trillions of dollars for the next bailout will likely be more inflationary. Any additional bailout should be accompanied with spending reductions (eliminate federal student loans and guarantees, eliminate federal defined benefit retirement programs for civilian and military employees, etc) and expanding the tax base with A 10 cent per $1,000 assessed valuation on virtual real estate (URLs). Amazon’s web address, for example, would probably assess at a trillion dollars, so that would offset a bit of the bailout.

    • Right. To the extent “inflation” or *the* inflation rate is a meaningful concept, the way people typically use the term doesn’t map well to extraordinary and short-term situations in which the scarcity of supply and a surge or absence of demand is likely to be temporary and reversed.

      Consider what happens to the price of gasoline in a hurricane (at least, inn the absence of anti-gouging rules). When the storm passes, everything will go more or less back to normal, but for a short while the demand goes way up, the supply is inelastic and and becomes extremely scarce. People are unlikely to associate the price movements with the big macroeconomic versions of the concepts of ‘inflation’ or ‘deflation’.

      Consider how distorted the real estate market is at present, with it being hard to sell and so many people not paying their mortgages or rent. But it’s reasonable to guess that whatever temporary effect this has on prices, that all the smoke and dust will clear and settle once things get back to normal, and that prices and payments will tend to converge with their pre-crisis trends.

  5. Is it higher inflation if as we see now, goods that were not generally available for awhile — like good toilet paper or all purpose flour — are appearing at higher prices than before? Did the adjusted CPI take into account the non-availability of many goods in much of the US and their greater availability in the last couple of weeks but at higher than pre virus prices?

  6. The only real inflation, as measured, in the US is generated by property zoning.

    The market tends to provide all other services and products in profusion. The world is glutted with automaking capacity, smartphone capacity, even oil and food capacity. Name me one industry that will not be able to meet demand easily in the next 10 years. I have asked this question for years and no one has ever answered.

    But the property zoning along the West Coast, New York, Boston and a few other locations is driving up costs and prices.

    But as I say, there are no atheists in foxholes and there are no Libertarians when neighborhood property zoning is under review.

    • All true. Why Inflation shows up in political economies (healthcare, housing, education, now stock market). & Why housing shortages /racism/riots/segregation is a northern and W city prob.

      It’s also bizarre to have coastal cities in same Union with same political currency as rural towns.

  7. But is the cost of living rising? Aren’t people shifting spending from more expensive sectors (travel, dining, entertainment) to cheaper ones (groceries, home-cooking)? For my wife and I, our personal cost of living has dropped considerably due to not eating out alone and will fall further this year by not taking the summer vacation (flights, rental cars, hotels, restaurants, etc) we’d been planning.

  8. Transportation services in the CPI consist of 3 items. One is airline fares where the CPI has been falling since 2013. The second is auto insurance where the one month drop was the first on record since the 1940s. I suspect that is some anomaly related to C-19 that is likely to quickly reverse. Maybe the data is all renewals since auto sales collapsed under the shelter in place rules. The third is auto maintenance and repair that has never had a negative observation. It looks to me like he is cherry picking data to support his ideology. He is using a single observation to support a theory about long run trends, something I would always find suspicious.

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