The Problem With Small Surprises: The Inflation Paradigm Shift

Posted by The Inflation Trader

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Written by: The Inflation Trader

The phrase “paradigm shift” is meant to sound dramatic. Like the sudden slipping of tectonic plates, a paradigm shift moves mountains (metaphorically). Deregulation of airlines caused a paradigm shift, transforming airplanes from airborne luxury cruises to cattle cars. Decimalization of equity bid/offers caused a paradigm shift, dropping bid/offer spreads about 90%.

Economic paradigm shifts can also be dramatic, as when the credit crisis of 2008 caused lending to contract almost overnight. But not all shifts are dramatic. The paradigm shift from horse-drawn carriages to ‘a car in every garage’ brought the world dramatically closer together. But it took a long time before it happened…before, anyway, it was obvious that it had happened. The paradigm shift was clear in retrospect, but not in prospect. It wasn’t as if people were waiting for the world to change: Henry Ford famously said that if he’d asked his customers what they wanted, they’d have said “faster horses.”

Core inflation, by its nature, rarely produces good surprises. Friday’s release was a case-in-point. Forecasters were looking for a +0.2%, and got a +0.2%, but they were actually looking for about +0.17% and got +0.23% instead. It doesn’t even look like a surprise, when the rounded data is announced, but it assuredly was one. The y/y core CPI, which decelerated last month for the first time in 16 months, rose back to 2.3% (although just barely, and shy of the high from January), after last month’s decline had produced a chorus of predictions that core CPI for the year would end up being in the low-to-mid 1% range.

It is hard to imagine that, following the 2008 collapse of Lehman Brothers, there were very many who didn’t see the paradigm shift. On the other hand, Henry Ford churned out millions of Model Ts before the wagon-wheel manufacturers went bust. Could we be in the midst of an inflationary paradigm shift without knowing it? Put another way, does the fact that many economists deny such a shift imply that there isn’t such a shift? Well, would the fact that many analysts still projected record profits for buggy-whip producers, which could plausibly have happened if our current research structures existed back then, have implied that there was no revolution happening in locomotion? I personally think it would have been very remarkable if an analyst covering such companies had deduced that the Ford (F) development would change the demand/supply balance for automobiles in such a dramatic way.