Sunday, August 11, 2013

Is There a Correlation between Real Growth Rates and Inflation? Yes & No

Is there a correlation between real growth rates and inflation rates?
From the data analyzed and presented below, there is virtually no correlation between quarterly real growth rates and quarterly inflation rates if the inflation rate is between -5%/yr and +10%/yr. However, there is a strong negative correlation between decade average real growth rates and the standard deviation of decade long inflation. In other words, what matters for growth is not the actual inflation rate (provide that it is low.) What matters is having a low standard deviation in the monthly inflation rate for an entire decade (or more.) The goal of this post is to show how these results were calculated.

Consumer Price Index
I've analyzed the monthly inflation in the consumer price index from 1913 to 2012 and graphed the inflation rate at each month. There are 1200 data points in the graph below. In addition to the actual data, I've plotted some black lines that represent the average inflation rate over the decade...the average monthly inflation rate in units of [per month]. The grey lines represent standard deviation about the average inflation rate. The brown lines represent the average yearly inflation rate over a given decade, such as 1913-1922, ..., 203-2012. Roughly, not exactly, the brown lines are 12 times larger in value than the black lines.