"Note the string of five consecutive months of 4%-plus inflation, and that the average for the 4th quarter was 4%, while for the first quarter of 2008 it was over 4.1%. Never mind whether that is the right number or whether there are problems with how it's calculated – that's a story for another letter. The key here is that if the BEA used the BLS number (remember, both groups are in the same Department of Commerce), it would show the economy shrinking by 1% in the 4th quarter and by almost 1% in the first quarter. That's not what the happy-talk analysts are saying.
But let's use the Fed's favorite measure of inflation, personal consumption expenditures, or PCE. The PCE has been about one-third less than the CPI since about 1992. The difference is in the way they are calculated. The CPI uses a weighted average of expenditures over several years. As I understand it, the PCE tracks changes in relative expenditures from one quarter to the next, assuming that consumers change their habits as prices rise and fall. In simplistic terms, if steak gets expensive, we substitute with hamburger or chicken. One index tracks those changes over years and the other (PCE) does it over quarters. Also, the PCE only tracks personal consumption and not imports or inventories.
If we use the PCE numbers (yet another measure using Commerce Department data), inflation was about 3.3% for both quarters, which would mean negative growth quarters by a few tenths of a percent. That would also mean two quarters of negative growth and a recession.
Further, GDP in the first quarter was helped by inventory build-up to the tune of 0.8%. In times of expansion it's good to see inventories grow, as that means companies are optimistic. But when the economy begins to slow, growing inventories mean that companies anticipated sales that did not materialize. That means that as inventories are allowed to fall in the second quarter, they will show up as a negative factor in second-quarter GDP."
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