Key Inflation Indicator Negative, But Deflation Is Not On The Way

 | Sep 29, 2013 08:19AM ET

There was an interesting nugget of data buried deep in Thursday’s GDP report from the Bureau of Economic Analysis: The rate of change of the deflator for personal consumption expenditures fell to an annual rate of -0.1 percent from the 0.0 percent rate reported earlier. An even broader measure of inflation, the GDP deflator, was also revised downward, although it remained positive. The PCE deflator, rather than the more widely publicized Consumer Price Index, is the Fed’s preferred indicator of price trends.

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The downturn in the PCE deflator prompted University of Michigan professor Justin Wolfers to ask, in a blog post on Bloomberg.com, Where is the Panic over Deflation? To be fair, Wolfers was quick to say that he himself was not panicking at a one-quarter downturn in a single inflation indicator. Still, it is a good question. Is this the time to begin worrying about deflation, or is it not?

It is not. Before reading too much into the downtick in the PCE deflator for the second quarter, we should check some forward-looking inflation indicators. One of the best is the inflation expectations measure published by the Cleveland Fed. It draws on price trends for Treasury Inflation Protected Securities (TIPS), bonds that carry inflation protection linked to the CPI. The spread between the TIPS price and the price of ordinary Treasury bonds of similar maturity indicates how much investors are willing to pay for inflation protection. The Cleveland Fed decomposes that spread into a measure of inflation expectations and a risk premium. As the next chart shows, after reaching record lows earlier this year, both the Cleveland Fed’s 5-year and 10-year expected inflation rates have moved up. Clearly, the upturn points to a reduced probability of deflation.

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Meanwhile, the Original post

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