2011-02-18

US Recession Indicators - February 2011

Net Monetary Base vs Inflation (spread)

The growth of the Net Monetary base (M0 minus excess reserves) over inflation is safely in positive territory with a reading of 409. This is a decrease from last month's reading of 478 but is still way above the historical average of 255. The increase in the past six months has been substantial, which is likely to mean that US GDP growth will continue strongly in Q1 2011. However the January results saw an annualised increase in inflation of 4.8% which, compared with an annualised decrease in the Net Monetary Base of -1.6%, sees the spread in negative territory (-642). Nevertheless an occasional monthly decline is common and is not indicative of an oncoming recession.

Note: A negative result implies that inflation is growing faster than the money supply, an event which indicates that a recession will occur within 1 to 36 months (with an average of 12 months)


Data Series:
St Louis Fed

AMBNS
EXCRESNS
CPIAUCSL
GDPC1
POP
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Federal Funds Rate vs 10 Year Bond Rate (spread)

The 10 Year Bond Rate has increased over the past few months while the Federal Funds rate remains at near zero. The December spread comes in at 322 basis points, well above the historical average and safely in positive territory.

Note: A negative result implies a highly restrictive monetary environment, an event which indicates that a recession will occur within 4 to 39 months (with an average of 22 months).
Note: If both the first and second graphs are negative at the same time it indicates that a recession will occur within 1 to 21 months (with an average of 11 months).




Data Series:
St Louis Fed

FEDFUNDS
GS10
GDPC1
POP

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Real Interest Rates

Inflation in the past two months has picked up considerably. Index figures and summaries are as follows:

November 2009: 216.956
December 2009: 217.158
January 2010: 217.458
October 2010: 218.970
November 2010: 219.240, 1.1% yearly, 0.1% monthly, 1.5% monthly annualised
December 2010: 220.186, 1.4% yearly, 0.4% monthly, 5.2% monthly annualised
January 2011: 221.062, 1.7% yearly, 0.4% monthly, 4.8% monthly annualised

The Federal Funds Rate remains at rock bottom at 0.17%, which means that real interest rates are still negative at -1.5%. Last month was -1.2%.

Inflation has picked up due to a combination of higher oil prices, higher food prices, and the effects of QE2. It remains to be seen whether these inflationary conditions will continue, and/or have a negative economic impact.

Note: Real Interest Rates are another way of measuring monetary conditions. While inflation implies that cash by itself is losing its value, a negative real interest rate implies that cash accounts in banks are losing value as well (even while earning interest). The IMF strongly recommends that economies keep real interest rates positive to preserve the value of money and to prevent investment bubbles from occurring.



Data Series:
St Louis Fed

FEDFUNDS
CPIAUCSL
GDPC1
POP


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2011-02-14

The magical GDP Deflator

I've just had a very important change in thinking. I'm no longer going to focus on the Consumer Price Index (CPI) as the main measurement of inflation, but the GDP Deflator.

When Gross Domestic Product (GDP) is reported, two figures are released. The first is called "Nominal GDP" and is essentially the latest measurement in current prices. Since prices are affected by inflation, a second figure is released called "Real GDP", which measures GDP after adjusting for inflation. A mix up in my understanding of this issue was quite embarrassing a few years ago, but it has remained in the back of my mind ever since.

The thing is that CPI measures consumer prices. It doesn't measure producer prices (which is a separate figure) or any other price movements. In my macro study of how inflation affects the money supply I searched for a more accurate representation of how inflation should be measured. The GDP deflator is the broadest measurement of inflation in an economy. If you want to measure the complete price change in the economy, look at the GDP deflator.

For instance. If you look at 2010 Q4, the CPI index moves from 217.224 in December 2009 to 220.252 in December, which implies an annual inflation figure of 1.39%. The GDP deflator index moves in the same period from 109.665 to 111.118, which implies an annual inflation figure of 1.32%. The GDP deflator and the CPI are rarely exactly the same, almost always move together, and only rarely is there a large disconnect between the two results. I suppose you could say that the CPI is an approximate measure of inflation, while the GDP deflator is the most complete figure we have.

Firstly, this has had broad implications with my recession predictions. The spreadsheets I have on this issue more than confirm my predictions when I replace CPI data with GDP deflator data.

Secondly, it has changed my opinion of what is going on in Japan. As someone who believes in Absolute Price Stability (neither inflation nor deflation over the course of the business cycle, with an inflation index averaging out at zero changes over the long term) I have often lauded Japan as being an example of what it could be like. Not any more. See here:



This index clearly shows that the GDP deflator in Japan has been negative since 1997. This is not price stability; it is deflation. If Japan had absolute price stability, the average result of the GDP deflator over the long term would not show much deviation, if at all. In 1997 the index was 103.115. If it was still around the 103 mark today, with movements between 101 and 105 in the intervening years, then that would constitute absolute price stability. As a result of this discovery, I have far less respect for the BOJ. Quantitative easing and an abandonment of mercantilist trade policy is what Japan should've done to prevent this deflation.

Here's another problematic graph.

2011-02-02

US Recession Indicators - January 2011

Net Monetary Base vs Inflation (spread)

The growth of the Net Monetary base (M0 minus excess reserves) over inflation is safely in positive territory with a reading of 480. The increase in the past six months has been substantial, which is likely to mean that US GDP growth will continue strongly in Q1 2011.

Note: A negative result implies that inflation is growing faster than the money supply, an event which indicates that a recession will occur within 1 to 36 months (with an average of 12 months)


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Federal Funds Rate vs 10 Year Bond Rate (spread)

The 10 Year Bond Rate has increased over the past few months while the Federal Funds rate remains at near zero. The December spread comes in at 311 basis points, well above the historical average and safely in positive territory.

Note: A negative result implies a highly restrictive monetary environment, an event which indicates that a recession will occur within 4 to 39 months (with an average of 22 months).
Note: If both the first and second graphs are negative at the same time it indicates that a recession will occur within 1 to 21 months (with an average of 11 months).




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Real Interest Rates


Low inflation and even lower interest rates mean that the current rate is still in negative territory at -1.21%. It remains to be seen whether the current situation encourages another investment bubble or simply encourages investors to reduce liquidity.

Note: Real Interest Rates are another way of measuring monetary conditions. While inflation implies that cash by itself is losing its value, a negative real interest rate implies that cash accounts in banks are losing value as well (even while earning interest). The IMF strongly recommends that economies keep real interest rates positive to preserve the value of money and to prevent investment bubbles from occurring.





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