The Fed Chairman has hobbled his credibility over the past year by continuously predicting that inflation is about to fall–only to have it keep right on rising. The good news for Ben: If history is a guide, we might soon be able to take him seriously again. Unless, of course, this is a re-run of the 1970s.
Asha Bangalore at Northern Trust looks at inflation trends through the past few recessions. The key point: With the notable (and scary) exception of the 1970s, inflation usually peaks a few months after the recession begins. Which means we might actually start to see it decline soon.
Inflation is a lagging economic indicator which peaks after an economic downturn has commenced and establishes a trough several months after a recession has ended and the next recovery is underway:
In the last recession, for example, inflation peaked 8 months after the business cycle peaked. This was an unusually long lag, but several months is common.
So where is the U.S. economy at the moment?… Our best guess is that the peak of the current cycle is December 2007/January 2008 or approximately around this time period. In other words, if history is a guide, the U.S. economy is probably at the brink of a turning point in inflation. This is entirely conceivable given the projection of weak economic conditions in the near term. Inflation expectations (as measured by the difference in nominal 10-year U.S Treasury note yield and the 10-year TIP yield) as of August 19 stood at 2.15%, down from 2.57% on July 3:
If only we could get that picture of the 1970s out of our minds. (Note how, in the top graph, inflation drops temporarily after the recession…and then skyrockets again. This is what happens when the country refuses to take its medicine. No signs yet that the country is willing to take it this time.)
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