12/10/2014 04:48 EST | Updated 02/09/2015 05:59 EST

Prices Are an Ocean Apart...For Now

Doug Allan via Getty Images

Price movements have grabbed the headlines in recent weeks. Commodity prices are falling, and as always, there are various arguments about the reasons this time. The implications are serious, so the debates are warranted. But the more pressing issue is recent movement in the general price level. Overall price growth has weakened lately, and there is renewed worry about disinflation and deflation (the dreaded Ds). Five years beyond the crisis, and we are still worried about this? What's going on?

First off, the worry is warranted. Recent consumer prices on both sides of the pond are hugging the zero-line. Central banks typically ratchet up the alert level when this happens, as previous bouts of either of the 'dreaded D's' have generally been ugly for the economy. Moreover, central banks don't have a developed playbook on deflation. Just ask Japan. Inflation is another issue; although it's the central banks' prime obsession, they boast a 25-30-year playbook that has worked extremely well over that period. The absence of workable strategies for combating price weakness makes the current context more than a little unsettling.

U.S. consumer prices were well-behaved through June, shaking off the blahs that accompanied the temporary weather-induced slowdown in the first quarter. However, there have now been four back-to-back months at or below zero growth, and the headline year-on-year growth is back below the 2 per cent level. Euro-area growth has been even softer. Weakness can be traced back to March, and even though the record before then was positive, it wasn't great. CPI for the region fell 0.1 per cent in October, heightening concerns. Year-on-year growth has now been below the half-per-cent marker since July.

Core inflation numbers tell a different story. By 'core', economists and statistical agencies are referring to that group of prices that are less volatile and subject to the vagaries of various international events. Traditional core prices strip out the volatile food and energy components, as the core measure is more helpful in setting the course for monetary policy. More sophisticated measures have been developed over time, but for our purposes, the more simple measure suffices. So, do core price movements tell a different story than the headline indexes?

Indeed they do. US core prices are jumping around lately, but on average they have been very close to the key 2-per-cent level over the past eight months. If anything, there are worries that the nascent rise in economic growth will soon put upward pressure on core prices, and that the Fed is actually somewhat behind the monetary policy curve. Remember, policy tightening needs to happen anywhere from 12 to 18 months ahead of price movements to nip them in the bud.

Core prices in the Euro Area are also on a different path than headline numbers, but the story is quite different from America's. Core prices in Europe are increasing at about twice the pace of the all-items headline rate. However, that's still not much to write home about. Core price growth has steadied at about 0.75 per cent year-on-year, less than half the pace in the 'States. Monthly growth is more of a worry. It saw back-to-back declines in September and October, and the only signs that things may pick up are the up-trend in retail sales and stabilized confidence. For the moment, the ECB is likely to remain on high alert, ready to go into action if need be.

The cross-Atlantic differences in price behavior have analysts wondering about divergent monetary policies. No doubt the doves will be active, pressing for a heavy dose of quantitative easing on the continent in an all-out effort to stave off deflation. The ECB has thus far resisted high-profile calls to do 'all that it takes', but is reserving the right to go into action the instant they feel the need. In this hesitation is a positive message: the ECB must see current price weakness as temporary. And it may get help from plunging oil prices: as lower pump prices free up more income for other expenditures, those prices may well take off.

The bottom line? The drama in the world of prices has turned the spotlight back on deflation. The US is nowhere near it, and has the opposite problem. Europe is running close to the line, but most seem to feel that it is temporary, and there are good reasons to believe that the worst will soon be past.