In the long run, we’re all spread

By Monday, February 15, 2016 No tags 2

President Harry Truman famously exclaimed, after dealing with a number of economists and economic predictions, that he needed a one-handed economist. Yes, we do have a tendency to opine back and forth, often cushioning our vagaries with “…on the one hand…on the other hand…” which so irritated the former US president. One of Keynes’ friends was to have said very much the same: “Ask four economists for a prediction and you shall get four different answers – five if Maynard is one of them!”

My head recently asked me to help him with a long run inflation prediction. ‘How far ahead’ I asked. ‘Five years’ was the answer. I then asked him if he wanted a side dish of mermaids and unicorns with his order. Yes, he has a sense of humour, so he laughed, shook his head in wry acknowledgement, and took what I gave him. Since I suspected that the inflation forecast was going to be used as an indicator of future salaries, I was briefly tempted to predict 15% inflation but I didn’t want to push it.

It struck me that I’d actually never been asked about inflation over a future five-year time horizon. I did some checking and basically nobody really wants to commit to anything beyond a time horizon of three years. Good call; when the most powerful central bank in the world predicts, in 2007, that there is no cause for worry, well…

truman - dewey was wrong

Dewey Defeats Truman from National Portrait Gallery via Photopin

So just how wrong were the election prognosticators?!

Influences on inflation

EU inflation is expected to linger down about 0.4 – 07% during 2016 and for once, most of the soothsayers are pretty much in agreement. There are few, if any, real inflationary forces at work at the moment:

  • US growth, while strengthening and resting on an eight year low in unemployment just under 5%, is not as robust as the Fed anticipated in December. Clearly the interest rate rise was premature and it looks increasingly likely that the rate will be lowered during the second quarter this year. US growth is still a global driver of demand and inflation in the world.
  • Stock markets in the US, Asia and Europe have dropped precipitously during January and this will certainly fuel uncertainty and thus sluggish aggregate demand. Coupled to increasingly slack property markets, we will hardly see any surge in optimism and wealth-based spending.
  • Key areas for global inflation – and the spread hereof – are Europe and China. The former is wallowing in an average unemployment rate of over 10% (only Germany, the UK and the Czech Republic are close to US figures) and China has just witnessed how thousands of labourers went back to villages over the holidays only to not return to the big cities due to scarcity of work. We have long seen the murmurings of how Chinese official figures have overestimated the current prediction of 6.9 to 7% growth – it does indeed look like the real figure is under 3%. It does not look as though China will see consumption become a major component of GDP just yet and falling exports during 2014 and 2015 are the main contribution to slower growth.
  • Last but by no means least, the drastic decline in the price of oil during the past three years has had an enormous effect on inflation around the world. This is frankly something that some very clear-sighted prognosticators saw over ten years ago (see Björn Lonmborg’s book “The Skeptical Environmentalist”) based on the astounding amount of oil and gas we know is still left in the main (historic) oil fields. The Pennsylvania and Oklahoma fields have an estimated 80% of the oil left – and oil has been pumped here for 150 years now. Hydraulic fracturing – ‘fracking’ – has increased monumentally in the US in the past decade and led to US dependency on oil going from 2/3 imported to 1/3. The price of oil has fallen by some 70% since 2014! OPEC continues to pump unabated (I personally relish situations where oligopolistic collusion breaks down!) and smaller firms are pulling out of the previously oh-so profitable tar sands of Canada. It is highly unlikely that we will see a surge of oil prices over the next five years.
oil glut

OIL – STOP THE SPILLING! on Vimeo by Leo Bar via Photopin

Oklahoma is still fracking strong!

All my colleagues in economics realise that smart prognosticators either predict ‘…inflation is going to go down…’ or ‘…by June, there will be a big change in inflation…’. In other words; predict WHAT is going to happen but not when…or WHEN something is going to happen but not what. Never both! Look up ‘Nouriel Roubini’ and tell me I’m wrong.

Final note: I have found very little data on how well inflation prognostication fits de facto inflation! I would think that there would be some serious studies where prediction inflation (three to five years ahead) would be matched with actual outcomes. I was hoping to find some sort of study where predicted and de facto inflation were matched over time and compared via a correlation coefficient. So far I’ve not found anything. Anybody who can help, please write to me!


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