Saturday, November 22, 2008

CPI decline biggest ever

In October, the Consumer Price Index [CPI] fell 1.0%, its largest decline ever (since the stats started being kept in 1947), although prices are still 3.7% higher than a year ago. Inflation is, like, so last summer, as an economic concern.

The decline in prices was led by a 8.6% decline in energy costs, which follows declines of 1.9% in September and 3.1% in August. Food prices rose just 0.3%, but are still up 6.1% year over year.

In addition to energy, prices also fell for apparel (retailers desperate to get customers in the door) and prices for both new and used autos also fell. But even stripping out food and energy prices, the core CPI fell 0.1%.

Under normal conditions, this would be a huge green light for the Fed to cut the Fed funds rate. However, these are not normal conditions. The Fed funds official target rate is just 1.0%, and even that overstates things since the effective Fed funds rate is just 0.37%. Thus, even if the Fed were to cut by another 50 basis points in December, it would still be behind the curve with the market. On the official target rate, there are just four 25 basis-point bullets left in the gun, and it is not clear just how effective those bullets would be.

The velocity of money is slowing like it never has before, or at least since the 1930's. "Velocity" is the technical term for people just sitting on their wallets and banks just stuffing every spare dollar into 3-month T-bills. This is very important since nominal GDP is equal to the amount of money in circulation times the velocity of that money.

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