Interest rates and the rate at which we trade US goods for foreign goods (both
knzn and
Stefan Karlsson note the importance of this terms of trade effect). As many observers indicated several years ago, if you borrow and consume in excess of production, sometime in the future, you may have to pay back by producing in excess of consumption. That process will be facilitated by a change in the terms at which home (US) goods exchange for foreign goods (see this
Council on Foreign Relations special report and references therein). And this is what we are seeing occur now.
The credit card bill has come due.
Nor is this a surprise to those who have been following the evolution of tradables prices. Figure 2 shows how goods import prices have moved with the dollar’s decline. Total goods import prices have risen more than the dollar decline since oil prices have jumped up. But even prices of imports ex-oil have risen substantially.
Figure 2: Log level of nominal dollar exchange rate against a broad basket of currencies (blue), goods import deflator (red) and goods import deflator ex oil (green), normalized to 2002Q1. NBER-defined recession dates shaded gray. Source: BEA GDP release of 31 July 2008, Federal Reserve Board via St. Louis Fed FRED II, and author's calclulations.
Another way at looking at the divergence between the GDP deflator and the gross domestic purchases deflator is to note the differential rate of inflation for the tradables (goods imports, imports ex. oil, exports) and the GDP deflator. That is shown in Figure 3.
Figure 3: Annualized quarter-on-quarter inflation rate for goods imports (blue), goods imports ex oil (red), exports (green), and GDP deflator (black), calculated as log first differences. Source: BEA GDP release of 31 July 2008, and author's calclulations.
Thus, it seems to me that we should anticipate that over time, we should continue to see a disjuncture between the GDP deflator, and what we think should be the price level.
This is not to deny the possibility that the GDP deflator might be revised upward. That could happen. But my view is that a lot of the puzzlement abounding can be resolved by recognizing the difference by the GDP deflator and the gross domestic purchases deflator.
