This is the sixth installment of the LEIPLINE. Our focus each quarter will be on the four variables for which we collect data and the implications of those data for the Jacksonville MSA overall. Since many of the data change for at least one month after we first report them, we have decided to wait until at least the middle of the following quarter to report each quarter's implications. Since the local CPI is the most significant variable that we analyze we will start with it.
The 2008.1 Jacksonville CPI
The change in the local CPI during the first quarter of 2008 was higher than any quarter since we began collecting the data in December 2001, and even higher than the national CPI. The aggregate effect through March produced a quarterly increase of just over 1.3%, with the annualized equivalent inflation rate at 5.52%. Fortunately, April's value was down four tenths, lowering the annualized inflation rate locally to a more reasonable 2.76%. Therefore, while Jacksonville exhibited higher inflation during the first quarter than the nation as a whole, after April, the national number is somewhat higher than the local. The local numbers were once again driven by fuel prices and housing prices, but several other categories revealed big jumps as well. Telephone prices rose two of the three months as did owner's rent of primary residence. The latter is hopefully an indicator of the beginning of a housing recover. Fuel prices, including both gasoline and fuel oil, grew dramatically during the quarter based on speculators seeking profits in oil markets as an alternative to U.S. and foreign stocks and bonds. This month we include yet another article on the influence of oil and gasoline prices, with emphasis on the impact that these commodities have on the reported CPIs both locally and nationally.
The outlook for the second quarter of 2008 relative to inflation is clouded. With oil prices continuing to rise without demand justification, it is hard to predict what will happen next. We believe that oil and gasoline are the latest bubble, driven by speculators from all over the world exiting stock markets for hoped for higher returns. If this trend continues during the higher demand summer months in the northern hemisphere, then the general level of prices is likely to rise even if the economy weakens further. What is necessary at this point is a stimulus to raise the value of the dollar to reduce oil speculation and bring loanable funds back into the standard credit markets to stimulate GDP. Unfortunately, the national economy and monetary policy appear to be headed in the opposite direction, stoking the stagflation (declining growth combined with escalating inflation).
Rates in Jacksonville during 2008.1 continued their rise towards the national rate, even after adjustments for seasonality. Specifically, the unemployment rate is now 1.5 percent higher than in March of 2006. LEIP only seasonally adjusts the unemployment rate (we do not calculate it), but doing so provides valuable short term insight into the changes from month to month. For example, the unadjusted unemployment rate in February 2008 fell from 4.6% to 4.4%, but the adjusted rate rose from 4.31% to 4.36%. In the first quarter again, the seasonal adjustment could not reverse the trend however, because unemployment did nothing but go up. There was a one tenth drop in April after seasonal adjustment, for some positive news. The Jacksonville MSA rate of unemployment continued its climb towards the national number, only just less than one-half of one percent below the national value. We were correct about employment last quarter, unfortunately, but what happens in the second quarter will depend a great deal on the recessionary pressures on layoffs. So far, layoffs both nationally and locally have been small, generating our belief that the economy is still better off than prior similar experiences would dictate. If we have to go out on a limb, we see unemployment rising marginally in the second quarter of 2008. Please see the article on the Phillip's curve
also included this quarter, the last article for David Frazier before he goes off to Chapel Hill for graduate school. David has been the primary student author of the LEIPLINE since its inception and he will be missed.
Leading Indicator (LEI)
The LEIP leading indicator was up nearly 2 points in the first quarter, but it remained virtually flat in April. However it is still nearly 3 points higher than the comparable national LEI on which it is based, but virtually identical to what it was in April 2006. However, looking inside the numbers reveals that the LEI bounced up and down through April with the primary constant that consumer confidence was falling throughout. Filings for unemployment insurance were surprisingly muted, with most of the positive growth driven by the growth of the money supply. Thus, the outlook for the second quarter of 2008 in total is as uncertain as we have seen it. Like we reported in February, the actions by the FED will be crucial since the real M2 money supply is such a major influence on the LEI, and the broader economy.
Stock Price Index
The local stock index was mixed in the first quarter of 2008. The local presence stocks continued to plummet while the local headquarters stocks recovered through March (although they fell off in April). While the DOW continues to remain relative near its peak, the local stocks seem to be reflecting the declining demand for U.S. stocks more generally. This outcome seems to be driven by the commodity bubble we discussed above as it relates to oil primarily. It is important to recognize that when the return to U.S. stocks occurs after the commodity bubble bursts, local stocks might be a strong investment, ceteris paribus.
The Bottom Line
Overall, 2008.1 was not a good quarter for Jacksonville or at the national level, but not as bad as we anticipated. Retail sales slowed, unemployment rose, and inflation accelerated. The LEI rose overall, but mostly due to a very strong March. The outlook for Jacksonville is not strong for the middle part of 2008. If, however, the housing market gains momentum, and high oil prices moderate due to a bursting bubble, then the outlook is much better and the chances of a recession diminish. However, the strength of the oil and gasoline commodity speculation seems to be too dominant to expect these changes during the next six months. Therefore, we forecast continued weakness until the November election, with the potential for worsening of the economy thereafter.
Of Gasoline Prices and the CPI: Or Why You Feel So Much Poorer!
Last quarter we revealed the realities of the relationships between oil and gasoline prices and the changing value of the dollar, inflation, and demand. This quarter we relate the growth in gasoline prices with the way in which inflation in the fuels category is calculated in the consumer price index (CPI). The reality is that the adjustments that have been made in the CPI to reflect gasoline's and other fuel's portion of the average market basket have not kept pace with gasoline prices, and thus, the CPI seriously understates the inflationary effects of rising prices for gasoline.
The CPI calculated by the Bureau of Labor Statistics and LEIP is a weighted average of a market basket of goods and services. The weights are periodically changed to reflect changes in the market basket over time. This methodology is called "chain weighting" and it has existed since 1999. However, the most recent weights are from 2005-06 and they thus predate the major escalation of prices of many products - most of all oil and gasoline.
However, employing these weights, despite the degree to which they are dated is instructive. In 2001 (when LEIP began), the weight for fuel was 3.998 implying that fuel made up just under 4% of the average market basket of goods and services, or that the average household spent just under 4% of their disposable income on fuel. That weight using the 2005-06 values is 5.482 or 37% higher. Unfortunately, gasoline prices were $1.08 per gallon in December 2001 and this week they are over $3.80 per gallon. This escalation in price reflects a 252% increase! Therefore, unless your household has cut back on your use of fuel extremely dramatically, the increase in the weight in the market basket of the CPI grossly underestimates what has happened to your allocation of your income to fuel; and so you have significantly less money to spend on other things. Consequently, if your household makes $50,000 and you have not cut back on your use of fuel at all (this may be somewhat overstated but economists recognize that the elasticity of demand for fuel is very small), the 4% of your income in 2001 is likely just over 10% in 2008. One of the realities of life is that you cannot spend the same dollar more than once, so 6% more spent on fuel means 6% less spent on other goods.
The bottom line is that the degree to which the CPI understates the inflation associated with fuel is quite large and this is independent of the other reality that fuel prices significantly affect the prices of a multitude of other products that may be understated in the CPI as well. Calculating the local CPI as part of LEIP has taught us a great deal about the process, but also much about the pitfalls.
The Local Phillip's Curve Revisited
This article was the last one written by David (Tyler) Frazier before he leaves the LEIP team for the Ph.D. program in Economics at the University of North Carolina at Chapel Hill. The entire LEIP program is indebted to David for his hard work, dedication, and statistical abilities that will be sorely missed.
During my nearly three year tenure with the LEIP project I have been fortunate enough to research many interesting topics that have had profound implications for the local economy. Therefore I feel it is only fitting that the last topic I write about be the same topic that originally piqued my research interests when I began writing these articles.
One of the most interesting relationships in economics is the link between inflation and unemployment. This relationship has been a major policy issue since the sixties. During this time Policy makers used the short run relationship between unemployment and inflation, known as the Phillips curve , to try and make accurate predictions about healthy levels of inflation and unemployment. This was possible because, in general, unemployment and inflation reach certain equilibrium values that are inherently functions of one another, meaning that unemployment cannot reach its "natural level" without some amount of inflation in the overall economy. Likewise, without job creation, inflation will grind to a standstill. To help policy makers decide what levels were acceptable in the long run, economists researched possible relationships between unemployment and inflation in the proverbial long run. However, in order to analyze these dynamics they first needed to understand the short run behavior of inflation and unemployment.
In the short run we expect a hyperbolic or parabolic relationship between these Macroeconomic indices i.e. (1/x, or x2). From previous research on the local Jacksonville economy we infer that the local economys' Phillips curve takes the following form. In the above graphical representation, we can clearly see the existence of a hyperbolic relationship between inflation and unemployment.
As an economy traverses into the long run however, the Phillips curve breaks down and forecasting the movements for long time periods becomes a little like finding a needle in a haystack. In general this problem stems from the fact that, in the long run not all economies operate the same. One countries' macroeconomic policy might be completely different from another's. Therefore, we cannot expect every country's Phillips curve, and thus its relationship between inflation and unemployment, to exhibit the same behavior over a substantial amount of time. It is theorized that as an economy first transitions into long run behavior, the Phillips curve will exhibit a vertical representation (Stock, Watson 1997). This makes sense because in the long run inflation and unemployment have already reached their equilibrium levels. The only changes that occur between unemployment and inflation are short "jumps" that quickly lead back to an equilibrium level.
What exactly constitutes a long run level is a question that can only be answered by the data itself. From the above description it would seem that when an economy first exhibits this long run behavior the Phillips curve would exhibit a vertical shape, and then presumably after a significant amount of time, some other non-linear trend would emerge. In order to determine whether the local economy has reached a sufficiently long run level of unemployment and inflation we plot the data and check for the emergence of this vertical trend.
What we see is a clear cut example of an economy that has began its transition to a long run stable trend in inflation and unemployment levels. The clear vertical trend tells us that the overall equilibrium levels of inflation and unemployment have been established and departures from these levels quickly lead back to equilibrium. This means that as of this moment the local Jacksonville economy is exhibiting long run stable behavior with regards to unemployment and inflation. Due to the fact that the economy undergoes constant fluctuation there is no guarantee that this stable long run behavior will persist for any specified amount of time. Therefore, when making long run business decisions like plant or workforce expansion, one must remember that although the economy is stable with regards to inflation and unemployment, things can change quickly. In order to be aware of any future changes with regard to inflation and unemployment we must carefully watch for the emergence of a non-linear trend in the long run Phillips curve and be sure to analyze the overall price level as it corresponds to short run inflationary pressures.
In conclusion, I would like to thank each of our subscribers to the LEIPLINE, our valuable sponsors (Heritage Capital, Business Valuations, the Florida Times-Union, and the UNF Foundation) and most of all, I would like to thank Dr. Paul Mason for his invaluable help in many aspects of my professional life. The LEIP Project would not be possible without Dr. Mason, and therefore we owe him our greatest thanks.
1) Journal of Economics Perspectives, Volume-1, winter 1997, 33-49. "The NAIRU unemployment, and monetary policy." Douglas Straiger, James H. Stock, and Mark W. Watson.