Some Lessons from
The Great Inflation and Disinflation
Peter Hooper
Chief Economist
Deutsche Bank Securities
Peter.hooper@db.com
1 212 250-7352
Torsten Slok
Senior Economist
Deutsche Bank Securities
Torsten.slok@db.com
1 212 250-2155
DISCLAIMER AND ANALYST CERTIFICATION ARE LOCATED ON THE LAST PAGE
Outline
• Quantifying trends and volatilities of inflation.
• Implications of inflation stabilization.
• Causes of the great inflation and disinflation.
• Could it happen again, and if so, why?
2
Inflation a little high for comfort recently
yoy%
3.0
yoy%
3.0
Consumer prices (PCE) ex food and energy
2.5
2.5
2.0
2.0
Fed’s
Comfort
zone
1.5
1.5
1.0
1.0
0.5
1996
0.5
1998
2000
2003
2005
Source: BEA,DB Global Markets Research
3
But its been a lot higher…
yoy%
yoy%
Consumer prices (PCE) ex food and energy
12
12
11
11
10
10
9
9
8
8
7
7
6
6
5
5
4
4
3
3
2
2
1
1
0
0
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005
Source:BEA, DB Global Markets Research
4
Inflation trend has fallen dramatically
since early 80s
%
12
PCE ex food and energy
(Q/Q, AR)
10
%
12
10
Trend
8
8
6
6
4
4
2
2
0
1965
0
1970
1975
1980
1985
1990
1995
2000
2005
Source:BEA, DB Global Markets Research
5
Volatility of inflation has plunged too
%
%
1.4
1.4
1.2
1.2
1.0
Standard deviation of change in
inflation trend
1.0
0.8
0.8
0.6
0.6
0.4
0.4
0.2
0.2
0.0
0.0
1965 1970 1975 1980 1985 1990 1995 2000 2005
Source: BEA,DB Global Markets Research
6
Inflation trends have fallen globally
25
25
Inflation trends
Germany
Japan
United States
United Kingdom
20
15
20
15
10
10
5
5
0
0
-5
1970
-5
1975
1980
1985
1990
1995
2000
2005
Source: DB Global Markets Research
7
Inflation volatilities have plunged globally too
4.0
Standard deviation of change in inflation trend
3.5
3.5
Germany
Japan
United States
United Kingdom
3.0
2.5
2.0
4.0
3.0
2.5
2.0
1.5
1.5
1.0
1.0
0.5
0.5
0.0
0.0
-0.5
1970
-0.5
1975
1980
1985
1990
1995
2000
2005
Source: DB Global Markets Research
8
Why does lower inflation and
especially lower volatility of
inflation matter?
• Anchoring of expectations
• Inflation risk premium and real
interest rates
9
Inflation expectations anchored at low level
10
%
9
8
7
FRBUS inflation expectations
%
10
Philly Fed inflation expectations 9
8
U.Mich 5-10yr inflation
expectations
7
6
6
5
5
4
4
3
3
2
2
1
1
0
1965 1970
0
1975 1980 1985
1990 1995 2000
2005
Source: DB Global Markets Research
10
Real interest rates have trended lower
8
US 10yr Treasury yield-SCF inflation expectation %
US 10 yr Treasury yield-FRB inflation expectation 9
UK inflation-adjusted 10 yr yield
8
US 10yr TIPS yield
7
7
6
6
5
5
4
4
3
3
2
2
1
1
0
1980
0
%
9
1985
1990
1995
2000
2005
Source: BEA,,FRB,DB Global Markets Research
11
Result: Rising asset values, falling saving rate
%
7
ratio
Personal saving
rate
6
14.0
12.0
10.0
8.0
6
6.0
4.0
5
2.0
0.0
5
Household Wealth,
ratio to to income
4
1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005
-2.0
-4.0
Source: BEA, FRB, DB Global Markets Research
12
What caused the great inflation
and disinflation?
• Accommodative monetary policy in the face
of inflationary demand and supply shocks
• Monetary tightening and behavior
consistent with a rules based policy
13
Monetary policy consistency
30
%
Deviations from Taylor Rule
25
%
25
United States
Germany
United Kingdom
Japan
20
15
30
20
15
10
10
5
5
0
0
-5
-5
-10
1970
-10
1975
1980
1985
1990
1995
2000
2005
Source: DB Global Markets Research
14
Trend core PCE inflation and policy rate deviations
from Taylor rule
%
Deviation from Taylor rule(output gap)
Deviation from Taylor rule(real time output gap, H-P based) %
Deviation from Taylor rule(Orphanides' real time output gap) 12
Trend in core PCE (rs)
12
10
8
6
4
2
0
-2
-4
-6
-8
-10
1965 1970 1975 1980 1985 1990 1995 2000 2005
10
8
6
4
2
0
-2
-4
-6
-8
-10
Source: BEA ,DB Global Markets Research
15
Output gap measures
%
8
Output gap,Current Data
Output gap,H-P filtered real time
Output gap,Orphanides real time
%
8
4
4
0
0
-4
-4
-8
-8
-12
-12
-16
-16
1965 1970 1975 1980 1985 1990 1995 2000 2005
Note: Measures the percentage deviation of actual from various measures of potential output.
.
Source: CBO, Phil fed, Orphanides (2003),DB Global Markets Research
16
What could cause inflation trend
and volatility to rise again?
• Politics
• Demographics
• Global factors
17
Politics
Barney Frank
January 2007:
• Fed policy is fair game
again in Congress
• No inflation targeting
on my watch.
• Fed needs to hold
interest rates down to
allow wages to rise.
Source :DB Global Markets Research
18
Inflation: a Political Influence
(PCE less food and energy)
yoy%
yoy%
12
12
Wright
Barney
11
11
Patman
Frank
Era
10
10
9
9
8
8
7
7
6
6
5
5
4
4
3
3
2
2
1
1
0
0
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005
Source:BEA, DB Global Markets Research
19
Politics contd.
• Fed and markets
have learned a lot
over the past four
decades.
• Has gotten Frank to
acknowledge that its
real wages that matter,
not nominal wages.
• May settle for
something less than
formal inflation target.
Source :DB Global Markets Research
20
Implications of ageing boomers:
• Slower growth of labor force and
potential output
• Massive increase in social
security and health care costs
• Higher interest rates
21
Demographics: Ageing Baby Boomers
25
% of population
1910
1920
1930
1950
1960
1970
1980
1990
2000
2010 1940
2020
2030
2040
2050
projection
% of population
25
20
20
20
20
15
15
15
15
10
10
10
10
5
5
5
5
0
0
0
0
0-9
0-9
10-19 20-29 30-39 40-49 50-59 60-69 70-79 80-89
10-19 20-29 30-39 40-49Age50-59 60-69 70-79 80-89
Age
90+
90+
Source: Census, DB US Economics Research
22
Labor force growth set to drop
Percent
100
Labor force participation rates: 2006
Percent
100
Male
Female
90
90
80
80
70
70
60
60
50
50
40
40
30
30
20
20
10
10
0
0
16-19
20-24
25-34
35-44
Age
45-54
55-64
65+
Source: BLS, DB US Economics Research
23
Dependency ratio age on verge of jumping
%
50
Population age 65+ as a percentage of the
population age 20-64
45
40
%
50
45
Projection
40
35
35
30
30
25
25
20
20
15
15
10
10
5
5
0
0
1960 1970 1980 1990 2000 2010 2020 2030 2040 2050 2060
Source: Social Security Administration, DB US Economics Research
24
Social Security spending nearing take-off
% of GDP
7
% of GDP
Social Security spending
projections
7
6
6
5
5
4
4
3
3
2
2
1
1
0
0
1962 1970 1978 1986 1994 2002 2010 2018 2026 2034 2042 2050
Source: CBO, DB US Economics Research
25
Medical spending set to blast off
% of GDP
25
20
Medicare and Medicaid
Medicare/Medicaid spending
projections
% of GDP
Assumes medical inflation
25
20
4-1/2%
15
15
3%
10
10
5
5
Social Security
0
0
1962 1970 1978 1986 1994 2002 2010 2018 2026 2034 2042 2050
Source: CBO, DB US Economics Research
26
Global factors could cause
inflation trend and volatility to rise
again
27
Global Dimension: Growing Imbalances
bn $
400
200
bn $
400
Middle
East
China
200
Canada
0
-200
Other/
stat
discrep
ancy
Japan
Other
Asia
Western Africa
Hemisphere
EU
US
India
0
Aus/NZ
-200
-400
-400
-600
-600
-800
Current account in 2005
Source: IMF, DB Global Markets Research
-800
28
US Net External Debt Growing Rapidly
Bil$
1000
Net international investment position of the US
500
Bil$
1000
500
0
0
-500
-500
-1000
-1000
-1500
-1500
-2000
-2000
-2500
-2500
-3000
-3000
1975 1979 1983 1987 1991 1995 1999 2003
Source:BEA, DB Global Markets Research
29
China’s reserves soaring
Billion $
1200
1000
Billion $
1200
1000
China's official foreign
exchange reserves
800
800
600
600
400
400
200
200
0
1999
0
2001
2003
2005
Source: PBC, SAFE, DB Global Markets Research
30
China’s inflation edging up
yoy %
6
yoy %
6
China cost of living index
4
4
2
2
0
0
-2
-2
-4
1998
-4
2000
2002
2004
2006
Source: CNBS, DB Global Markets Research
31
China asset markets: looking bubbly
yoy%
140
120
100
yoy%
12.5
Shanghai stock price index (ls)
10.0
China house price index (rs)
80
7.5
60
5.0
40
20
2.5
0
0.0
-20
-40
1998
-2.5
2000
2002
2004
2006
Source: CNBS, Shanghai stock exchange, DB Global Markets Research
32
China moving toward currency flexibility
Yuan/US$
8.3
8.2
%
Yuan/US$ exchange rate
2
Level (ls)
13wk % change ar (rs)
0
8.1
-2
8.0
-4
7.9
-6
7.8
-8
7.7
2005
-10
2006
2007
Source: FRB, DB Global Markets Research
33
China/Asia restraining US inflation
YoY%
3
2
1
Average inflation ,1996-2006
PCE ex food
and energy
YoY%
3
Prices of US
imports from
emerging Asia
US total non-oil
import prices
2
1
0
0
-1
-1
-2
-2
-3
-3
Source :Haver, DB Global Markets Research
34
But the restraint is small and diminishing
YoY%
0.0
YoY%
0.0
-0.1
-0.1
-0.2
-0.2
-0.3
-0.3
Estimated impact of
Emerging Asia on US Core
PCE inflation
-0.4
-0.4
-0.5
-0.5
-0.6
1996
-0.6
1997
1999
2000
2002
2003
2005
2006
Source :Haver, DB Global Markets Research
35
Wrap-up
• Inflation and disinflation are monetary
phenomena
• Inflation trend and volatility are near a low point.
• Longer-term risks to inflation and rates, largely
to upside, include political, demographic, and
global forces.
• Low and stable inflation expectations do not
afford complacency at the Fed.
36
Torsten Slok, Ph.D.
Director/Senior Economist, US Economics
Deutsche Bank Securities, Inc.

Torsten Slok joined Deutsche Bank Securities in the fall of 2005
and is a senior member of the US Economics Team.

Prior to joining the firm, Dr. Slok worked at the OECD in Paris in
the Money and Finance Division and the Structural Policy Analysis Division.
Before joining the OECD he worked for four years at the IMF in the Division
responsible for writing the World Economic Outlook and the Division
responsible for China, Hong Kong and Mongolia.

Dr. Slok studied at Princeton University and University of
Copenhagen. He has published numerous journal articles and reviews on
economics and policy analysis.
37
Analyst Certification
The views expressed in this report accurately reflect the personal views of the undersigned lead analyst(s). In addition, the undersigned lead analyst(s)
has not and will not receive any compensation for providing a specific recommendation or view in this report. Torsten Slok
The information and opinions in this report were prepared by Deutsche Bank AG or one of its affiliates (collectively “Deutsche Bank”). The information herein is believed by
Deutsche Bank to be reliable and has been obtained from public sources believed to be reliable. With the exception of information about Deutsche Bank, Deutsche Bank
makes no representation as to the accuracy or completeness of such information.
This published research report may be considered by Deutsche Bank when Deutsche Bank is deciding to buy or sell proprietary positions in the securities mentioned in this
report.
For select companies, Deutsche Bank equity research analysts may identify shorter-term opportunities that are consistent or inconsistent with Deutsche Bank's existing,
longer-term Buy or Sell recommendations. This information is made available on the SOLAR stock list, which can be found at http://gm.db.com.
Deutsche Bank may trade for its own account as a result of the short term trading suggestions of analysts and may also engage in securities transactions in a manner
inconsistent with this research report and with respect to securities covered by this report, will sell to or buy from customers on a principal basis. Disclosures of conflicts of
interest, if any, are discussed at the end of the text of this report or on the Deutsche Bank website at http://gm.db.com.
Opinions, estimates and projections in this report constitute the current judgement of the author as of the date of this report. They do not necessarily reflect the opinions of
Deutsche Bank and are subject to change without notice. Deutsche Bank has no obligation to update, modify or amend this report or to otherwise notify a reader thereof in
the event that any matter stated herein, or any opinion, projection, forecast or estimate set forth herein, changes or subsequently becomes inaccurate, except if research
on the subject company is withdrawn. Prices and availability of financial instruments also are subject to change without notice. This report is provided for informational
purposes only. It is not to be construed as an offer to buy or sell or a solicitation of an offer to buy or sell any financial instruments or to participate in any particular trading
strategy in any jurisdiction or as an advertisement of any financial instruments.
The financial instruments discussed in this report may not be suitable for all investors and investors must make their own investment decisions using their own independent
advisors as they believe necessary and based upon their specific financial situations and investment objectives. If a financial instrument is denominated in a currency other
than an investor’s currency, a change in exchange rates may adversely affect the price or value of, or the income derived from, the financial instrument, and such investor
effectively assumes currency risk. In addition, income from an investment may fluctuate and the price or value of financial instruments described in this report, either
directly or indirectly, may rise or fall. Furthermore, past performance is not necessarily indicative of future results.
Unless governing law provides otherwise, all transactions should be executed through the Deutsche Bank entity in the investor’s home jurisdiction . In the U.S. this report is
approved and/or distributed by Deutsche Bank Securities Inc., a member of the NYSE, the NASD, NFA and SIPC. In Germany this report is approved and/or
communicated by Deutsche Bank AG Frankfurt authorised by Bundesanstalt für Finanzdienstleistungsaufsicht. In the United Kingdom this report is approved and/or
communicated by Deutsche Bank AG London, a member of the London Stock Exchange and regulated by the Financial Services Authority for the conduct of investment
business in the UK and authorised by Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin). This report is distributed in Hong Kong by Deutsche Bank AG, Hong Kong
Branch, in Korea by Deutsche Securities Korea Co. and in Singapore by Deutsche Bank AG, Singapore Branch. In Japan this report is approved and/or distributed by
Deutsche Securities Inc. The information contained in this report does not constitute the provision of investment advice. In Australia, retail clients should obtain a copy of a
Product Disclosure Statement (PDS) relating to any financial product referred to in this report and consider the PDS before making any decision about whether to acquire
the product. Deutsche Bank AG Johannesburg is incorporated in the Federal Republic of Germany (Branch Register Number in South Africa: 1998/003298/10) Additional
information relative to securities, other financial products or issuers discussed in this report is available upon request. This report may not be reproduced, distributed or
published by any person for any purpose without Deutsche Bank's prior written consent. Please cite source when quoting.
Copyright © 2007 Deutsche Bank AG
38