Monday, 24 November 2008

No Inflation, no growth?

The good news from last week's economic data is that inflation is gone, at least for now, in the United States. The bad news is that economic growth has probably gone with it.

On 19 November, the Labor Department reported that the consumer price index (CPI) fell 1.0 percent in October. Consumer prices excluding food and energy -- the so-called core prices -- also fell, though by a smaller 0.1 percent.

From a year ago, overall CPI was higher by 3.7 percent in October, well down from a peak of 5.6 percent in July. Core CPI was higher than a year ago by 2.2 percent in October, but this rate is down for the second consecutive month after exceeding 2.5 percent in August.

The fact that consumer prices fell in October could be an indication that the US economy is already in recession. In the past, a declining trend in the inflation rate, especially the core rate, has often been triggered by a recession. Indeed, core inflation, which lags overall inflation, usually falls only after several months into a recession. In the 2001 recession, the year-on-year core inflation rate actually peaked right at the end of the recession.

Therefore, the decline in both overall and core consumer prices in October may be a sign that the US economy has already been in recession for several months.

Such a conclusion would be consistent with the gross domestic product (GDP) figures from the Commerce Department. According to the department's advance estimate, US GDP had shrunk at an annualised rate of 0.3 percent in the third quarter. This followed a 2.8 percent growth rate in the second quarter.

More recent economic data indicate that the third quarter contraction probably continued into the fourth quarter.

On 14 November, the Commerce Department reported that retail sales in the US fell by 2.8 percent in October, reflecting weak consumer demand. Weak consumer demand goes a long way in explaining the decline in consumer price inflation.

The underlying trend in industrial production also looks weak, notwithstanding a strong headline number for October. A Federal Reserve report on 17 November showed that industrial production was up 1.3 percent that month. However, the increase was mainly due to a rebound from a hurricane-induced 3.7 percent plunge in September output. Excluding the effect of the hurricanes as well as a strike at Boeing, the Federal Reserve said that output shrank by 0.7 percent in each of the past two months.

If the US economy is indeed in recession, it would be joining other major global economies.

On 14 November, Eurostat reported that in the third quarter, GDP in the euro area shrank 0.2 percent from the previous quarter. This followed a similar 0.2 percent contraction in the second quarter, thus marking two consecutive quarters of contraction and confirming a technical recession.

On 17 November, it was Japan's turn to confirm a recession after the Cabinet Office reported that GDP shrank 0.1 percent in the third quarter after having shrunk 0.9 percent in the second quarter.

We are only half way through the fourth quarter but if the data released so far are any indication, we could soon be seeing a second consecutive quarter of GDP decline in the US too.

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