The 2007-9 Financial Crisis turned Iceland into a major tourist destination, as a newly cheap currency combined with affordable flights and natural beauty. For anyone with plenty of time and a moderate amount of money, chasing the newly-cheap destination seems like a good travel strategy.
Since January 2020, here are the countries where the US dollar has gained the most vs the local currency:
And yet, measures of prices that consumers pay are much more stable. The most widely tracked measure, the CPI-U, is up 4.2% over the past year. That’s through April — and keep in mind that it’s starting from a low base since March-May 2020 saw falling prices). The Personal Consumption Expenditures index, often preferred by economists, is up just 2.3% (though that’s only through March).
So what gives? Do these consumer measures understate inflation in some way? Or is the increase in commodity prices telling us that consumer prices will increase soon?
Let’s take that second question first. Do higher commodity prices necessarily lead to higher consumer prices? The answer is a clear no. First, we can see that in the data. The producer price index for all commodities (such as corn and lumber) is up 12% over the year (through March, with April data coming out tomorrow). That’s a big increase. But as the chart below suggests, that probably will not lead to 12% increases in consumer prices. It probably won’t even lead to a 5% increase in consumer prices.
Notice two things about this chart. First, commodity prices (the red line) are much more volatile than consumer prices, both on the upside and downside. Second, there really isn’t much of a lag, if any. The direction of change is similar in both indexes, almost to the month. When producer commodity prices go up, consumer prices also go up, that very same month, but not by the same amount. So all of that 12% increase in producer prices is probably already reflected in consumer prices.
Why might this be? Simple supply and demand analysis (hello Econ 101 critics!) can tell us why.
I’m advising a senior thesis for a student who is examining the strength of Purchasing Power Parity in hyper-inflationary countries. Beautifully, the results are consistent with another author* who uses a more sophisticated method.
For those who don’t know, absolute purchasing power parity (PPP) depends on arbitrage among traders to cause a unit of currency to have the same ability to acquire goods in two different countries. If after converting your currency you can afford more stuff in foreign country, then there is a profit opportunity to purchase there and even to re-sell it in your home country.
Essentially, when you make that decision, you are reducing demand for the good in your home country and increasing demand in the foreign country (re-selling affects the domestic supply too). Eventually, the changes in demand cause the prices to converge and the arbitrage opportunities disappear. At this point the two currencies are said to have purchasing power parity – it doesn’t matter where you purchase the good.
So does PPP hold? One way that economists measure the strength of PPP is by measuring the time that it takes for a typical purchasing power difference to be arbitraged away by 50% – its ‘half-life’. The more time that is required, the less efficient the markets are said to be.
The ex-ante question is: Is PPP be stronger or weaker during hyperinflationary periods?