Inflation/Deflation 1

I initially envisaged a series of posts on forecasting inflation, treating inflation/deflation as phenomena more or less at arms length.

However, I began assembling posts on this topic while in the US, before traveling to Japan – where currently I am (now in Osaka).  In Japan, I’m pulled by the attractions of all the sights, the temples, the great food, and it’s cherry blossom season. Also, I just brought a tablet, leaving the laptop at home. I find that finishing a blog post nicely is hard with this Android device.

But now I have something to say – and I add some of the details of the initial post I planned on at the end of these comments.

Deflation in Japan

It’s cherry blossom season in Japan, and hotel reservations got scarce. So we had to book in clean, reasonably priced hotels that still had space – and it turns out these are sometimes on the margins of what you might call “the party district.”

I think watching the revels of young people here – uproarious and loud, all night and well into the early morning – provides a flesh-and-blood side to the general movement of prices – in this case the on-and-off deflation in Japan.


Check out Japan and the Exhaustion of Consumerism.

So even though I am on the 8th floor of this really nice business hotel in Osaka, the “party district” is full of young Japanese men and women (what I would call at my advanced tenure “youth”). Anyone who thinks the Japanese are reserved and repressed should put their ear to my window high above the street, listen to the revels – the howls and screams, often in unison by groups – as people get more and more booze under their belts through the evening and then through until morning. Go down at 6am and you will find couples and groups staggering around, quite drunk or loud, unruly groups of guys…..

The Original Material

As with gold and interest rates, there are several steps in coming to grips with inflation forecasts, not the least of which is the immediate prospect for price change in various global regions and inflation forecast performance over various short and longer term forecast horizons.

Generally, inflation forecasts are being adjusted downward for 2014 and 2015. The Survey of Professional Forecasters First Quarter 2014 Survey, for example, projects

…current-quarter headline CPI inflation to average 1.7 percent, lower than the last survey’s estimate of 1.8 percent. The forecasters predict current-quarter headline PCE inflation of 1.3 percent, lower than the prediction of 1.8 percent from the survey of three months ago.

The forecasters also see lower headline and core measures of CPI and PCE inflation during the next two years. Measured on a fourth-quarter over fourth-quarter basis, headline CPI inflation is expected to average 1.8 percent in 2014, down from 2.0 percent in the last survey, and 2.0 percent in 2015, down 0.2 percentage point from the previous estimate. Forecasters expect fourth-quarter over fourth-quarter headline PCE inflation to average 1.6 percent in 2014, down from 1.9 percent in the last survey, and 1.8 percent in 2015, down 0.1 percentage point from the previous estimate.

Over the next 10 years, 2014 to 2023, the forecasters expect headline CPI inflation to average 2.3 percent at an annual rate. The corresponding estimate for 10-year annual-average PCE inflation is 2.0 percent.

Lower and lower rates of inflation merge into deflation, of course, which is considered to be a risk currently for the eurozone. CNN Money reports that, in March, that the

..annual rate of inflation fell to 0.5%, down from 0.7% in February and weaker than most economists were expecting. Inflation is now at its lowest level since November 2009.

Actual deflation seems to be the reality in Spain, Portugal and Greece. Thus, the Wall Street Journal reports that ..

Spain’s preliminary estimate for March said the European Union-harmonized consumer-price index slipped 0.2% compared with the same month last year, down from February’s increase of 0.1%.

The data makes Spain the latest euro-zone country to slip into deflation. Prices have been dropping in Greece since early last year, and Portugal last month recorded its first year-over-year decline since 2009.

Japan is special among advanced industrial economies in having inflation which dipped into deflation several times for relatively extended periods, dating back to the 1980’s.

Japan is especially relevant, of course, because the Bank of Japan (BOJ) was the first to experiment with the zero-bound on short term interest rates and its aggressive bond-buying program – both features found in the US and European central bank environments today.

What is the Forecasting Problem?

Forecasting inflation rates have been one of the signature efforts of many macroeconomic forecasting organizations and agencies.

As a result, there is considerable research on the stochastic nature of inflation/deflation time series and the relative performance of univariate (autoregressive) versus multivariate forecasting models. It’s interesting to look over this literature with an eye to evaluating, in specific contexts, whether declining inflation rates can mean price change will dip below zero in key economic regions.

[I will add the finishing touches to this post, when I can. But meanwhile, this reflects my current thinking. Soon – hyperinflation]