Inflation, Macroeconomics & #TheDress

Inflation data at the moment — at least in the advanced economies — is reminding me of #TheDress.

For those who missed at the fuss /have better way to spend their time than studying internet memes, this dress was matter of heated debate a few weeks ago:

Some people looked at it and saw a white and gold dress, others saw a black and blue.

For what it’s worth — Wired explained the science behind this at the time and, for me, it appeared to keep changing colour every time I looked at it.

In macroeconomics at the moment — this chart is #TheDress:

Inflation in the US, Eurozone and the UK. Economists, investors and analysts staring at this picture tend to see one of two things: either an oil price driven boost to real incomes or the start of a worrying slide into deflation.

The optimistic view is that the recent slide in inflation is mainly reflective of the oil price collapse. And few people think the big advanced economies would seriously be better off with oil back at $100.

Lower oil functions as an effective tax cut to firms and consumers, raising their real incomes and ultimately financed by foreign oil producers. An almost unambiguous boon for the big developed economies in the short run.

The pessimistic view points out that inflation has been falling for longer than oil and frets over the onset of deflation. Widespread falls in prices can have pernicious effect on an economy, the fear is a debt-deflationary slide where lower falling prices feed through into falling profits and falling wages. This pushes up the real value of debt at a time when debt burdens are already high.

In a UK context, I’ve blogged before on when I’ll start to worry about deflation. The short answer is “not now”, the longer answer is “if core inflation (excusing food and oil) starts to fall and if wage growth heads south again”.

Until falling prices become widespread and wages start to respond, deflation isn’t a real threat. Of course deflation, when it occurs, can be such a huge problem that even if the threat isn’t the most likely outcome — it still makes sense for central banks to pay attention to it.

All of that said, until very recently it seemed not only justified but sensible, to worry about deflation in the Eurozone. Counter-intuitively enough, the recent fall in headline inflation makes that concern much less pressing.

What has happened is a disinflationary fall in the price of oil has pushed headline inflation into negative territory. But by boosting real incomes has made a deflationary slide less likely.

Or — good falling prices, in the short run, has saved Europe from bad falling prices in the longer run.

Macroeconomics can be odd like that.

The big question in the coming months (especially in the Eurozone) is whether the positive income shock from lower commodity prices is enough to boost aggregate demand by enough to turn around a longer running disinflationary trend. For the time being, that looks to be the case.

At the moment the current ‘deflation scare’ in the West looks to be just that — a scare. To see if it’s really something to worry about, we need to look away from headline CPI and focus on core inflation and wage growth.