Inflategate: Everything You Know About Inflation Is Wrong

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New studies show that how much money a central bank prints may be less significant to inflation than commodity prices.

As the markets grow stronger and stronger, there is no metric more important for investors than inflation. Investors’ expectations of rising inflation to corroborate the strong trends in financial stocks and the falling rates in government bonds makes it a very important number in investing.

However, common theories that are used to forecast inflation are not working.

According to David Lafferty, chief strategist at Natixis Global Asset Management,   inflation “takes so many forms”. Inflation is this year’s “wild card”. Natixis manages about $900B in global assets.

It has been established for a while now that central banks have the tightest control over inflation. When inflation rises, central banks raise interest rates in tandem; when inflation falls, central banks lower interest rates.

Why is this important to investors? Well, bond speculators and investors generally see yields as indicative of interest rate movements, and use this knowledge to predict inflation levels as well as central bank actions.

But, after years of maintaining this ideology, it’s starting to become very vague as to what central bankers can do about inflation; in other words, it may be possible that central bankers can’t do much about inflation at all.

Last Friday, five notable economists presented research at a monetary-policy conference, saying that the main indicators used to comprehend the behavior of inflation don’t actually explain it.

Let’s put this into perspective. Suppose you have an economy consisting of two pencils and two dollars. According to the theory, each pencil must be worth $1. But when the central bank issues another $2 in the economy, then inflation causes each pencil to be worth $2.

This is not all; in fact, Arend Kapteyn, chief economist of UBS, calculated that 84% of the deviation in inflation is a result of shifts in oil and fuel prices.

Chart by the Wall Street Journal
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