I have been a critic of the official inflation rates for quite some time. Recently, some have taken me to task for this. Brad DeLong chastises me, saying "Barry Ritholtz Does Not Seem to Understand the Purpose of "Core Inflation." Economics and… phrases the issue thusly: What is the core for?
These criticisms miss my main point. But that’s probably my own fault, for not explaining the issue better. After you’ve posted on the same issue a few 100 times, you assume everyone has followed your line of thinking. Today’s commentary will attempt to clarify that.
Let’s start by framing the issue: Regarding inflation, these are the questions I want to explore:
1) What is the actual, real world, rate of inflation?
2) Why does the BLS model — the "official" inflation rate — vary so greatly from the real world? How significant is the spread between the two?
3) Why does the Fed Focus on the Core rate, and not the actual rate? What are the Fed policy repercussions of this?
4) What does this mean to Consumers? Investors? Savers?
(Our prior explorations of those questions are here).
Long time readers know I do not believe that the BLS CPI data
actually reflects the true price increases of the real world. Further,
the Fed’s focus on the core rate has significant repercussions for
policy. Additionally, the debasement of the U.S. dollar means that
U.S. have seen their purchasing power eroded just as surely as if
inflation were even higher.
Let’s look at few new charts to see if they can shed any light on these issues. (For you "play along at home" types, here is the inflation data in Excel, via Bloomberg: CPI_vs. Core inflation.xls).
Any good economist will tell you that inflation is primarily a monetary phenomenon, so let’s go to the relationship between Money Supply and Inflation, via Now & Futures:
chart courtesy of Now and Futures
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Note the massive increase in M3 money supply. (Why the Fed decided to cancel the reportage of this key data point, we will leave to another discussion).
What has this increase in money supply meant for CPI? Let’s look at the headline versus the core inflation data for the past 5 years:
chart courtesy of Michael J. Panzner
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(Note: the plummeting inflation rate in the summer of 2006 was caused by a change in the widely followed Goldman Sachs Commodities Index — now owned by S&P — which temporarily sent Oil under $60).
Let’s look at the spread between the two rates:
chart courtesy of Michael J. Panzner
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Since late 2002, the core rate dramatically misrepresented actual inflation. This led to the Fed taking rates down too low, and leaving them there too long. The repercussions of this have been very significant, and are still being felt today — from the credit crunch, to $80 dollar crude oil, to huge increases in food prices, to unaffordable housing.
The bottom line is that ultra low rates, and big increases in money supply, sent the U.S. dollar to 15 year lows, raised the costs of all goods denominated in dollars, and lowered the standard of living for many people — perhaps most — living in the U.S.
This is why its is preferable for the BLS and the Fed to offer less spin on inflation, and to report actual, real world data — not an artificial construct that consistently under-reports inflation.
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I’ll have more on this later . . .
the core-CPI statistic is the biggest fraud on the american public since WMD.
it took awhile for people to wise up to the WMD sham, but eventually they did.
this will be no different…
“…the debasement of the U.S. dollar means that U.S. have seen their purchasing power eroded just as surely as if inflation were even higher.”
This is a pure non-sequitor. Unless you mean “measured inflation” rather than “inflation” you have said that inflation is higher than inflation. If you really mean “measured inflation” then you are using you premise as an argument for your premise. That is not a good way to make your case.
A further weakness to the statement is that “debasement” is not what one would call a neutral, objective term. Much of your 100 or so efforts to make this case have equally relied as much on rhetorical flourishes like that as on fact.
You claim to be after the “real” rate of inflation, but fall back on M3, which you assume is an iron-clad determinant of inflation. That is generally known as “begging the question” I believe.
The problem is not that DeLong has missed your core argument. The problem is that you think you have made a strong argument when you have not. Your religious zeal has eroded your objectivity. Go back. Answer the criticism offered by DeLong and others objectively, without resort to rhetorical special pleading or circular arguments and maybe you’ll will learn and become more convincing in the same effort.
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BR: I plead guilty to the usage of the word debasement.
My assumption is that a 30% decline in the US dollar versus other currencies would qualify. How much does the US dollar have to fall before the word debasement is acceptable — if ever?
Or asked via Stephen Colbert, “How can I be objective when the facts themselves are biased?”
Perhaps someone more knowledgable than I can answer this: If the core rate is a dramatic misrepresentation of actual inflation, what can the informed investor do to leverage that “disconnect” to their own advantage?
If there is no real value to be gained in knowing “the truth” then the knowledge just becomes an intelligent conversation that parallels discussing politics — in the end, politicians are all liars but what are we going to do about it?
Now I understand why Plato, fortunately for us all, gave up politics for philosophy…
The point that the incorrect inflation number causes the Fed to apply incorrect policy is telling. Using the actual rate (ie: wages vs cpi have declined since 2000) would have identified the massive house price bubble earlier. Clearly, that large deviation from long-term normal ratio of housing price to income would have indicated a problem.
Barry, I’m curious as to why you would use charts created by someone who I believe is predicting financial armageddon rather than using the government’s own charts of CPI and Core CPI? Essentially, they should both be the same, so I’m curious as to why you chose Panzer’s rather than the official versions.
Secondly, the chart you posted shows that there is currently no spread between the Core and All-items CPI. Bullish, no?
The BLS uses the Core statistic for monetary policy as it is not as volatile as the All-items data. If the All-items data was instead used, we might expect to see huge swings in monetary policy, as the gov’t would be reacting a very volatile index. I doubt that the gov’t would be any better than most market timers, and this approach would likely be disasterous. Instead, the Core is used for policy making as it is obviously less volatile and allows for carefully measured changes over time.
I haven’t read all your posts on this topic, but what I have read does not suggest a better solution for guiding monetary policy.
Finally, why has not anyone addressed the likelihood of falling inflation due to falling home prices?
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BR: I asked Mike to create the last two charts for me, as I was traveling w/o access to all of my work in the office, he has access to Bloomberg, and he is a wizard with Excel.
Barry – excellent charts and they help clarify your argument but kharris makes some good points, albeit rhetorically. Being curious took my own pass at digging into those questions which is at: http://tinyurl.com/327bdt .
If you look back CPI is more volatile but tends to converge on CPIx, as historically do both the PPI and PPIx. Where the argument hangs together is if a) we’re seeing a l.t. structural shift in food & energy because of the BRIC impact on world energy supply/demand balance. Much more worrisome, to me, is a recent, unprecedented and rising gap between cumulative PPI and CPI. The 2nd related question is whether or not, after 25 years of secular deflation, we’re enterring a new world of rising expectations.
Which when you stop to think about is pretty much what the Fed has been trying to tell us. The second hidden thought is that the economy has adjusted incredibly well and resiliently to the upward pressures. Did we get lucky, or is it a downturn in the economy or are we just finishing an adjustment process to higher energy prices and moving to a new plateau ? Or some combination ?
How do you counter the position that using M3 is useless as it much more reflects demand for money. On past Kudlow shows you have raised M3 to have it quickly countered that it’s a false measure of money supply, rather is a better reflection of demand. In fact, all your measures, the typical guests on his show would claim are useless without considering demand side of the equation. It has been pointed out that Russia has enormous money supply growth, but only because demand is even higher, therefore do they have inflation? Can you discuss the expansion of money supply without including figures to discussing concurrent money demand?
Russia has no inflation? Da, because the ruble has appreciated from 34 to 25 to the dollar. Bought a flat in Moscow for $114,000 in 02. Sold it in 04 for $185,000. I understand it is now worth $300,000. Russia used to be the biggest user of U.S. cash in the world besides the U.S… Now it is Euros. Even Russians understand inflation better than our politicos. We need more glasnost here.
I wish people would stop using “Begging the question”, for an oldtimer like me who remembers the original meaning, I would prefer “Asks the question”, if that is what they mean.
Unless you mean “measured inflation” rather than “inflation” you have said that inflation is higher than inflation. If you really mean “measured inflation” then you are using you premise as an argument for your premise. That is not a good way to make your case.
Um, I don’t see him doing that.
BR
(1)compare _prices_ (various CPI) with money supply
(2)makes the case that some price measurements track money supply, some don’t.
(3)The one the Fed uses (core) is the one that does not.
(4)using the core as a proxy measurement of monetary inflation is bad
(5)using the core as a measurement of cost of living is bad.
Actual money supply, CPI-U, track well. If one were to look for a means to track monetary inflation, why would one use core, rather than CPI-U?
BR is making the case that use of core would be to understate monetary inflation.
You claim to be after the “real” rate of inflation, but fall back on M3, which you assume is an iron-clad determinant of inflation. That is generally known as “begging the question” I believe.
Use price of dollars in dollars and have a perpetual inflation of zero. By changing the things we measure, we can have a result of measured inflation of zero, deflation, or inflation. Who knows the real rate? But if you were to use a price index to measure the effects, Why would you use one that eliminates most of the things where the effects would show up?
Using the definition of the St. Louis Fed that inflation is a rise in general prices caused by excessive monetary expansion, the rate of monetary expansion becomes critical.
Gary North has these comments: “….in April, 2007, I compared the four major monetary aggregates as predictors of price inflation. Only M1 was remotely accurate over the last four decades.
Mish has come up with a new aggregate, which he calls M-prime. He symbolizes it as M’. Using Shostak’s article as a guide, he argues that M’ is superior theoretically because it does not include any credit transactions, i.e., “sell this asset and get money.” I agree with his assessment.”
The full article: http://seekingalpha.com/article/47419-is-the-us-printing-money-like-mad has charts from the St. Louis Fed of monetary base which shows the monetary base has been falling and in a downtrend since the end of 2004. If excessive money is inflationary, these charts appear to show that money creation is not the reason for rising prices. Then what is the reason?
Plainly, the only substitute for money supply is debt expansion. Tame consumer price index with a debt bubble – that sounds vaguely familiar….
1. Inflation really is a monetary phenomenon. But this is only is a half of the full thruth. Monetary supply is driven by monetary demand, not vice versa. (othervise the Fed would use this control mechanism all the time to make infaltion curve. ). So, something behind monetary demand actually drives inflation as a process. The Fed are just reactive not proactive.
2. The difference between core CPI and CPI (indices themselves not rates of change, i.e. inflation rates)is a piecewise linear function time.
This is obvious from figures 5,6, and 7 in my old post
http://inflationusa.blogspot.com/2007/07/what-is-difference-between-cpi-and-core.html
Therefore, quantitatively, there is no difference between core CPI and CPI, the former is teh sum of the latter and linear time fucntion A(t-t0), where t0 is 2003,
and A=-1.5
3. Inflation is an almost precisely measured macroeconomic variable in sense of quantitative modeling. It is not the same than to measure TRUE inflation, but the BLS measures consistently the SAME portion of this true inflation. For numerical modeling, one needs just to calibrate using linear coefficient, as we know.
On the other hand, one can have an unlimited discussion on social, demographic, economic effects of inflation and what is the distance between measured and true inflation.
4. The precision of the inflation measurements is proved by its stict dependence on the change rate of labor force level (i.e. employment + unemployment).
http://inflationusa.blogspot.com/2007/08/can-we-predict-inflation-and.html
(Links in this post go to working papers with related analysis and data sources)
Thus, inflation is a process driven by only one force – the change in labor force level.
All rather silly. Inflation isn’t a real measurable thing of course. There is not “basket” of measures that net out to any actual reality.
Decide what you want to happen and then find a policy measure to fit it. It’s just a lie.
Housing prices were all over and inflation didn’t move. You telling me that’s accurate?
What is needed is a “price matrix” that measures prices for a few hundred common items in 10 or 20 most populated places. This would then be released…not any one aggregate that makes it look like an oversimplified idiotic function.
When oh when will economists quit acting like they know something from oversimplified and idiotic “functions?” What a joke.
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BR: We actually made repeated comments about how OER understated Housing Inflation as prices were rising.
See these posts for more details
Therefore, quantitatively, there is no difference between core CPI and CPI, the former is teh sum of the latter and linear time fucntion A(t-t0), where t0 is 2003,
and A=-1.5
You think so? A constant unidirectional error over time (how many years now?) has accumulative effects.
And what’s to say that in the future, when the direction becomes inconvenient, the measurement wont be reconstituted ala Boksin?
The idea of excluding food and energy because they are more volatile has always troubled me. Suppose you’re trying to evaluate a company with 10 divisions, and 2 of those divisions have extremely volatile quarterly results. Would you simply exclude those divisions from the analysis? Few if any analysts would take such an approach; most would simply apply some form of smoothing technique to the divisions in question.
kharris doesn’t make good points; and the heavy rhetoric redounds against, rather than in his or her favor.
The essence of the argument, as I have read it over the past year or so, is that the market utilizes measures provided by the government as givens for established mathematical formulae which accurately illustrate certain financial realities. The free market reflects the aggregated responses of actors to these realities. The government has, by virtue of its assumption of the power “To coin money, regulate the value thereof, and of foreign coin, and fix the standard of weights and measures;” (U.S. Const.,Art 1, sec 8.) has created a situation where an efficient market demands that “the value thereof” be accessible, and the government has ‘fully occupied the field’.
When the information that the govenrment provides is false or incomplete, the market acts without correlating to reality; much like a person jumping of a 100 foot cliff while thinking it is a 1 foot drop.
The offense is the mis-defining of inflation. dblwyo attempts to mitigate this by stating that CPI and I are separate terms, separately defined. This is correct as far as it goes, but the government employs CPI as a given for policy decisions for which the formula requires I, such as setting entitlement rates, and taking monetary and political policy decisions.
Where the rubber hits the road, in these cases, is the political and financial expectations of the market actors. Social Security was accepted by the voting public because it was a program designed to alleviate the scarcity experienced by pensioners. When the government undermines the intent of that negotiation with the public by not alleviating said scarcity to the extent promised or implied because they only adjust the ‘return’ of the deal to the ‘other side’ of the negotiation according to CPI in the face of more rapidly declining purchasing power per dollar, then the scarcity experienced by the public and pensioners is not alleviated.
In short, it is a lie that frustrates the intent of and injures one of the parties, i.e., fraud.
And debasement is a precise term meaning “to reduce the exchange value of (a monetary unit)” (Merriam-Webster). When 1 dollar will not pay the same fraction of my rent, or purchase the same amount of a commodity because the government has “regulated its value” lower by excessive money creation, then it has been, indeed, debased. And, since the government is the sole entity with the power to do so, it must also be the exclusive party in blame.
So, no, the claims are not ‘merely rhetorical’, and the complaint is not that “inflation is more than inflation”; rather it is that “the actual debasement of our currency and economy is more than what the lie that the sole arbiter of the mutually agreed to term ‘inflation’ is telling us it is.” The implications of that have been the substance of several months of posting.
Not related to this thread, but the bad-news-is-good-news thing happened again today. From the Yahoo finance page:
“Stock prices are higher in early trading today as some investors read a larger-than-expected increase in unemployment claims as support for another interest rate cut.”
All that I really need to know, as just a simple Middle-Class worker, making $60K, and trying to hold onto what savings I have, is that when I go to the grocery store, the bill is higher week over week for the same list of stuff. When I pay my energy bills, they are higher month over month, even though I do my best to use less and less.
The price of a Frididaire means nothing to me, clothing is put out in a wide range of prices and quality, and I don’t buy new cars. Plasma Screen TVs? Oh, please… I don’t even have cable. Very little of what is referred to as “the core” means anything to me.
What DOES effect me, and the very poor, and you rich investor-types up on the Street, is the cost of Food and Energy– period. Those two things effect ALL Americans, and they must be included in the mix. The problem is that we consumers don’t even get to hear about the REAL inflation rate, anymore, as the news agencies have stopped even mentioning it anymore. It’s as if we’re all supposed to believe that we are just imagining that our CORE BILLS aren’t constantly going up.
Many people in America have been priced out of buying many of those items considered a part of the CORE, and THAT is the problem. The CORE applies to a slowly diminishing class of consumers, any more. We NEED both sets of data– the REAL and the CORE to accurately surmise the purchase power of our dollars– otherwise, our ability to make proper financial judgements goes out the door.
So, put the esoteric books and charts away, as trying to justify the switch to CORE Inflation as the only measure that matters only breeds cynicism from those of us who actually have to live in the economy that the Street Poindexters have created.
Obviously, no one on the Street actually buys a gallon of milk any more. If the Poindexters actually did, they’d notice that the price of oil to fuel the farm machines, and the demand for corn ethanol, has driven up the price of cattle feed, and blown the price of milk through the roof. That is the inflation that matters when you don’t get a Million dollar bonus every year. Believe me– your nanny feels that pain when she goes home to her own house and family at night.
–mf
Begging the question, I still want to know if these people are using the core inflation rate from the BLS as the inflation assumption in their retirement portfolio?
If so, expecting fuel, food, and medical to go up at the government spun rate will leave you pretty short.
seems the numbers and reports are for the purpose of purporting SALES
in the land of capitalism and jungle laws – can’t you fudge for your own cause?
bank conglomerates / hugh retailers know – they acquired that knowledge – not you all – Uncle Sam asks, but does he buy?
The CPI and the CPI-XFE decoupled around 1986. Since that time the trend has been for the CPI-XFE to overshoot the overall CPI. Indeed, the core CPI level is still above the overall CPI level.
That is, there has been more total inflation in core-CPI than in overall CPI.
This extends naturally from the fact that as the technology advances commodities prices tend to fall in real terms.
The big question is whether you believe the current run up in commodities is the result of a weak dollar or the result of a rapidly industrializing China. I stand with the latter in which case it makes little sense to restrict money supply growth.
Moreover, I don’t understand how people can simultaneously be convinced that housing is overheated and due for a long price correction and have a problem with OER.
If you believe the housing market will correct to fundamentals won’t we see falling or flat housing prices until they come back in line with rents?
In that case isn’t the appropriate long run view of the cost of housing rents?
Now you might argue that the FED should target asset prices and not allow housing bubbles to be created but that is different from assuming that the run-up in housing has dramatically changed the long run price trend.
Well put, mf.
As the masses begin to question the published government statistics, given their obvious disconnect from the stark reality at the local store, cries will be heard up and down the entitlement roster for higher cost of living adjustments. The game will be up.
IMHO, the Fed is fighting inflation by deliberately understating CPI so that all the COLAs (cost of living adjustments) in a whole lot of people’s pensions etc will be lower than otherwise.
http://finance.yahoo.com/q/bc?s=%5ETNX&t=1y
http://finance.yahoo.com/q/bc?s=%5ETNX&t=my&l=on&z=m&q=l&c=
While I’ll admit that taking the debating position that eschews inflation is ultimately untenable, for now the two charts above are the judges of whether it’s leading to inflationary expectations or not, and the answer is not at the present.
True, the dollar has already deflated the purchasing power of U.S. citizens much more than core would indicate, but the dollar’s been low against world currencies before, only to rebound. Much of that potential rebound (should it occur) would offset the dollar’s losses against other currencies.
China and India alone are still v-a-s-t depositories of untapped d-e-f-l-a-t-i-o-n, worldwide. It’s like they are bottomless pits of deflation, denominated in labor wages.
In the late 80s and early 90s, commodity prices took a nosedive. Farmland fell 50% in some areas. Feeder cattle dropped under 50 cents.
—
Woodshedder,
What you may not know is that Barringo is being a bit sarcastic about the change in Goldman Sachs’ commodity index that reclassified the standard gasoline commodity contract deliverable in New York Harbor standard terms. Many suggested at the time that the abrupt and unexpected change was politically motivated just for the purpose of demonstrating low inflation (that whopping drop!) prior to the mid-term elections. I have no opinion about that, but just recant that debate for you.
Consequently, Panzer wouldn’t be m-i-s-r-e-p-r-e-s-e-n-t-i-n-g the chart to establish his opinion that core inflation is not worrisome… he’d just be using actual data, h-o-n-o-r-a-b-l-y, to attempt to establish intellectually his own interpretation that it’s not worrisome now, and his interpretation that the Fed a-l-s-o interprets it as not worrisome. That’d help clear the way for another rate decrease, and the market almost always interprets that as bullish. That’s what you want isn’t it? I think you must know that without further cuts, the bullish case isn’t so strong.
You ought to send Panzner some flowers.
Maybe these:
http://www.theflowerexpert.com/content/growingflowers/flowersandseasons/pansy
BTW, unless I’m in error, Panzner’s not worried inbout inflation now. “It’s the least of their [the Fed’s] worries, Larry,” he said recently on Kudlow.
Thank you, gn.
All that before my first cuppa.
Inre:Bill– For discussion’s sake, Federal Government Servants still working under the GS/FERs system will receive a 3.5% COLA (tied to CPI). But, talking about coming up short: Government Employees working under the nefarious NSPS system will only get a 1.5% COLA, with the balance between the two systems being put into the NSPS “Pay Pool,” where those employees will have to “perform to earn” the rest. The Pay Pool determines whatever BONUS an employee will receive vis the performace of his/her co-workers (shares of the Pool). So, under the NSPS System, 1/2 COLA = an “earned bonus.” MAGIC! Dark Magic.
THOSE people are going to really feel the bite of REAL inflation, as they lag behind year-to-year. A one-lump-sum, half of which is eaten up by simple COL, coming just in time for the Holiday and Heating Bills, won’t stimulate the economy much, and will barely keep them floating. Another whole set of educated cynics with a jaundiced eye for the CPI.
This is just one, off-the-path, demonstration of how the CORE effects many in a very negative manner.
–mf
A website,
http://www.shadowstats.com/cgi-bin/sgs/data
has reconstructed the original M3 to a five-nines (.99999) correlation. It’s currently running at 14% annualized…but there’s no inflation.
Barry, 2 important points that you may want to consider, even though I am sure you have known it already:
1) Headline CPI with Food and Energy prices are much more volatile than Core, but they both tend to follow core inflation EVENTUALLY, and therefore Core Inflation was preferred in the earlier years by FED. But FACTs show that this is no longer true in the last 4 years. Core Inflation measurement is losing its objectivity and predictive power, and has disconnect from Reality.
2) BLS is SECRETLY doing Double standard of measuring CPI inflation — they substitute lower price foods if one item shoot up in prices (they think you should eat lower quality fatty pork if your regular fish prices shoot up). However, when come to computer or telecomunication equipments or Appliances or cars, they would very SUBJECTIVELY measure the quality of new item and priced it as if DEFLATION is occuring.
For example, Dell 5000 series cost $1000 1 year ago. This year, Dell 5000 has more upgrades and power but sell of $1000 (but you cannot buy back the old Dell 5000!), and BLS is saying that there is a Deflation because you get more upgrades for the same $1000.
So, by confusing public with the word SUBSTITUTION, the BLS is under-reporting the inflation in the very comparable food and energy prices, and yet BLS is over-reporting the Deflation in Computer/Telecommunication/Electricals/Cars.
To be objective, the BLS should have maintained the quality measurements — remove substitutions in Food and Energy.
Gosh, I have a lot to answer here.
I’ll start with MonkeyFist. You say the gov’t is deceiving you, yet you find your way to this blog, but yet can’t find your way to the Gov’t website where the Core and the All Items numbers are reported? Hogwash.
GN, do you propose the COLA is adjusted down when the All Items report goes into negative inflation?
Eclectic, the Barringo bit was not lost on me. Being very familiar with the gov’t charts, I know that Panzer is not misrepresenting anything. I was just wondering if there was not an ulterior motive for BR to direct readers to Panzer’s site (Panzer is predicting financial armageddon, is he not?) rather than to the actual gov’t site where the data is reported. Just seems that in a discussion where BR seeks to clarify his position, it would help to use actual gov’t graphs.
As for a bullish or bearish case, I could care less, as I will make money in either market. I just enjoy a good debate.
cranky,
The observation about the difference between core CPI adn CPI in the USA is as follows: (Figures are in my post)
”
So, we have found that the CPI and core CPI are very similar with some lag and that the CPI has a larger volatility. A reasonable next step is to study the difference between core CPI and CPI, as displayed in Figure 5. The difference is apparently characterized by presence of three distinct periods. Between 1960 and 1981 it is more or less stable and varies in the range from +2 to -2 units of index. Between 1981 and 1999, the core CPI was growing consistently faster and a gap of about 10 units between these two indices was created through 1999. If to assume that the evolution of both indices is driven by a stochastic process like random walk, then the deviation between the indices is just the difference in stochastic trends. It is more reasonable and reliable to assume, however, that there is a tight link between the variables, which provides a linear growth of the gap between them. For purely stochastic and independent variables such a linear behavior is highly improbable. Figure 6 presents the difference and the best-fit line obtained by linear regression. The goodness-of-fit is very high – 0.96, i.e. deviations from the straight line are very small. The line has a positive tangent of 0.67. As a result, the core CPI grew faster between 1981 and 1999. Because the CPI inflation is predefined by the labor force growth rate the evolution of the core CPI is also predefined.
There was a short turbulent period between 1999 and 2003. Something similar was observed near 1979 and 1982. The gap reached its peak value in 1999 and in 2003. Then the gap has been closing in line with a faster growing CPI. Nevertheless, the CPI was consistently below the core CPI, as Figure 1 demonstrates. This “structural break” likely forced the Fed to switch from the headline CPI to the core CPI as the target. If to extrapolate the currently observed rate of convergence between the CPI and core CPI, as displayed in Figure 3, one can estimate the intercept time somewhere between 2009 and 2010. The linear convergence trend is very robust with Rsq.=0.86, as was the divergence trend between 1981 and 1999. This convergence is much faster – approximately 1.6 units of index per year. Therefore, one can expect that the price for food and energy will grow faster than that for the items in the core CPI. (Likely, a good investment idea at this time horizon.)
Figure 7. Linear regression of the difference between the core CPI and CPI for the period between 2001 and 2007. The goodness-of-fit is 0.86, and the tangent is -1.57.
What will happen beyond 2010? It is likely that the CPI will “overshoot” the core CPI and will be growing further and further above the core CPI. On the other hand, GDP deflator and CPI will drop below zero level after 2012. This means that the core CPI will be decreasing even faster than CPI and might reach negative zone earlier than in 2012. So, the next five years are not good for those who have personal income in the lower half (or even more) of personal income distribution in the USA, since their expenditures are mainly for food and gas
When analyzing the Fed’s decision and its influence on real economy, one has to bear in mind two fundamental observations about inflation, real GDP growth, and interests rates.
First, correlation between inflation and real GDP growth in close to zero for any time shifts between these two time series for the period between 1948 and 2006. Effectively, inflation does not influence real economic growth at all. At least, any claim about the existence of such influence should be proved somehow.
Second, the overnight interest rate (monthly values), as defined by the FOMC, has the highest correlation with the headline inflation when shifted eight months ahead. It means that inflation drives the decisions of the Fed. They wait until the pattern is clear and tune the rate to the inflation. Therefore, headline inflation drives interest rate.
One can conclude that such macro variables as real GDP and inflation do not depend on interest rate. Why is it so important then?
Simple answer, it forces redistribution of profits and incomes among economic agents. What can be more important individually?”
Shawn, as a consumer, do you not substitute one good for another if you feel the price point or the spread has gotten too high? You must presume the consumer will continually buy the highest priced item, regardless of how substitute items are priced.
When reading Mr Brad Delong
« However, when increases in inflation are confined to (i) energy and (ii) food prices, odds are that the increase is transitory and will be self-limiting. Hence the concept of “core inflation.” «
This sentence looks as a postulate driving a demonstration (fine they are few of them but they have the merit of not been proved otherwise )
But here ?
How long is transitory, how much is transitory and how is the self limiting process initiated?
To this quasi-trained observer’s eye, CPI-Core’s trajectory should be what the Fed keeps its eye while using the CPI-Total as the benchmark for where the interest rate should be pegged. I can understand why they don’t want to try to chase the CPI-Total, bouncing all around, but they’ve lost sight completely of the fact that the recent interest rate level has been set to low. Why is that so hard for the Fed to understand and implement?
BR – “What is the actual, real world, rate of inflation?”
There is NO SUCH THING in the context you’ve asked the question, and the questions which follow from it.
In the real world, BR’s actual rate of inflation is almost certainly a very different animal than Estragon’s.
The incidence of a rise in food prices, for example, falls more heavily on lower income strata and have different savings, spending, investment, and policy implications than would, say, an increase in imported car prices. Even knowing that however, we still need to understand the distribution of income growth in order to begin to understand the implications.
Ultimately the fed appears to be more concerned with whether there’s a credible threat that inflation expectations will rise among those in a position to do something about it.
Quite frankly, the people being hit with inflation currently have a limited ability to do much about it. Whether this is “right” in a moral sense is a different matter than whether it’s right strictly in an analytical sense.
Isn’t the “core” question: How long of a time frame does “transitory” in nature, entail? Quantifying inflation becomes a practice in futility if one cannot imput the pertinant information. Personally, I feel that the FED uses the Core number as an obfuscating device, in order to tackle “Expectations.” But if Head-line, becomes a persistant bugaboo, doesn’t the Fed run a credibility risk, by persistantly saying it isn’t so Joe?
CHECK OUT TRICHET’S COMMENTS TODAY FROM VIENNA….
Woodshedder: “do you not substitute one good for another if you feel the price point or the spread has gotten too high? You must presume the consumer will continually buy the highest priced item, regardless of how substitute items are priced.”
So, you are telling me that CPI is supposed to measure my monthly budget, as that’s what my “cost of living” is gonna be?
The whole picture has got so confused for me that I’ve gone back to real basics – viz. does a dollar buy ME that same amount as last year ? Of course, I don’t actually keep records and I know my PCs, camcorder, LCD TV get steadily cheaper, but I expect that so it doesn’t factor in, but my parking, groceries, beer, eating out is more expensive and I DON’T expect that so I reckon things are more expensive. That’s it, and if inflation EXPECTATIONS are what matter to the Fed then they have the answer. I expect inflation to go up whatever jawboning they try to do.
It all got confusing because the BLS, a supposedly neutral arbiter started fiddling the statistics – so I stopped believing in them and I won’t buy TIPs for that reason too.
No doubt, inflation is always a monetary phenomenon as I was taught but the measures of money are hopelessly compromised. I look at the St. Louis Fed Adjusted Monetary Base, I look at Fed Temporary operations running totals ( slosh report at http://www.gmtfo.com/RepoReader/OMOps.aspx ) , I look at derived M3 but its all contradictory and so I simply discard it!
Somewhere truth is statistics and transparency in Fed operations has got so compromised that I just follow my intuition and personal experience and not only is that what inflationary expectations is about but the lack of trust is also a precursor to a stampede out of money and into assets, ANY hard assets.
-K
“When reading Mr Brad Delong
« However, when increases in inflation are confined to (i) energy and (ii) food prices, odds are that the increase is transitory and will be self-limiting. Hence the concept of “core inflation.” «”
Yeah right! Tell that to the Canadian producers (I mentioned them ’cause I know about them) of pork and chicken. The demand from China had them expand their operations at an unprecedented rate for the last 10 years. And there are still a LOT of people in the Middle Empire to come into the middle class for a long time to come.
And what about energy demand? Take a look at the car production in China. How much energy will these new cars will consume in the next decades?
“Transitory”…reminds me of this exchange between 2 Chicago Cubs’ fans:
“They never win! Been like that since 1908!!”
“Come on now! Anyone can have a bad century, no?”
Francois
Francois, Cubs in 4, no I mean 5, no I mean 4 or 5 hundered years! lol
Atlantis, if you really are worried about inflation:
http://wikimapia.org/#lat=10.995457&lon=-65.379982&z=16&l=3&m=a&v=2
The idea of measuring inflation is just a master’s thesis run amok. At its core its politicians using bad academics for their purposes. How else to explain the unhinging of world prices after 1914?
Ask yourself, if you had to lend a million dollars to be repaid in 10 years, how would you lend it in order to be as certain as possible to receive the same purchasing power 10 years hence?
Would you even consider indexing it to the CPI? Really?
Look, if you hate the idea of using the core because it excludes food and energy, try the median or 16% mean trimmed CPI from the Cleveland Fed here.
Does this look like out-of-control inflation to you?
«BR – “What is the actual, real world, rate of inflation?”
There is NO SUCH THING in the context you’ve asked the question, and the questions which follow from it.»
«we still need to understand the distribution of income growth in order to begin to understand the implications.»
Exactly, when people talk about inflation, the question is always “whose inflation?” because unless prices all move at roughly same speed in roughly the same direction, different consumers will experience different rates.
«Ultimately the fed appears to be more concerned with whether there’s a credible threat that inflation expectations will rise among those in a position to do something about it. Quite frankly, the people being hit with inflation currently have a limited ability to do much about it.»
I reckon that it entirely intentional, and the techniques used to limit the growth of the CPI are based on the assumption that the people whose incomes are affected by the CPI no longer have the political power to proof their income against inflation by other more disruptive means.
The rationale for indexing was to protect the standard of living of wage earners when they could otherwise protect it by striking and negotiation: better to automatically give them inflation-proofing raises than trigger lots of catch-up strikes every time there was inflation.
So the CPI used to reflect the power of unions to inflation proof the incomes of wage eaners one way or another. But wage earners no longer have the political power to do that, so the CPI is a pointless bit of appeasement from the point of view of the bosses and the parties they sponsor. As Warren Buffet said, his class is waging clas warfare and they are winning. There are plenty of economists very willing to side with the winners.
«The bottom line is that ultra low rates, and big increases in money supply, sent the U.S. dollar to 15 year lows, raised the costs of all goods denominated in dollars, and lowered the standard of living for many people — perhaps most — living in the U.S.»
But it also made for enormous profits and huge incomes increases for a lot of other people, people who generously sponsor quite a few congresspeople — the party of inflation is huge because inflation does create a lot of winners. These winners surely don’t want the good time (for them) to end.
What’s good for Mozilo is good for America! :-)
Thanks for the mentions and links BR (aka Fearless Wonder), much appreciated.
Thankfully there was little moaning & groaning about M3. I added M2 into the chart to help deflect it… and I also note that M3 changes in the chart slightly lead M2.
Note also that the same relationships apply prior to 1900 and back to 1865 too (1865 is as far back as M2 & M3 are available), although they’re tighter after the Fed was created in 1913.
In other words, so what about credit or Mish’s M-Prime (which I helped create with Mish by the way) or TOMOs or base – the raw and actual factual data is very clear.
One of the “oddest” things to me about all the noise & BS regarding core CPI is that if food and energy has that much volatility, haven’t any economists at the Fed or BLS ever heard of smoothing via moving averages or similar?
In the immortal and paraphrased words of Bugs Bunny – “What a bunch of maroons!”.
All truth passes through three stages. First, it is ridiculed. Second, it is violently opposed. Third, it is accepted as being self-evident.
— Arthur Schopenhauer (1788-1860)
«3) Why does the Fed Focus on the Core rate, and not the actual rate? What are the Fed policy repercussions of this?»
Barry, you can use this argument: while CPI defenders may argue that it does fairly represent a broad-based measure of ”inflation” (whatever that is), they cannot dispute that the current definition of the index results in numbers that are perhaps 1.5x to 2x lower than the definition that was used in the 1970s. This cannot be disputed because that the definition has changed is an easily documented fact, both definitions are documents, and one can compute the index oneself as it was defined in the 1970s, as ShadowStats.com does.
Having established this, there are only two possibilities:
* The fans of the current CPI are right, and in the 1970 ”true” inflation was much lower than most people’s lying eyes reported, and Volcker is not a hero but the biggest scoundrel or moron.
* The fans of the 1970s CPI are right, and in the 2000s ”true” inflation is much higher than the government reports, and Easy Al and Helo Ben are astute, generous politicians.
I would like to see a fan of the current CPI seriously argued that the 1970s were afflicted by widespread inflation illusion…
Actually, let me see if I can’t answer some of Barry’s questions:
“1) What is the actual, real world, rate of inflation?”
The core CPI is a good first approximation of this. The median and 16% mean trimmed CPI measures I referred to above are even better.
Ah, but that’s not what Barry is looking for at all, I’ll wager. The key is that he’s confusing “changes in the cost of living”–which is approximated by the headline CPI–with “inflation.” Inflation is an increase in the money price of goods and services arising from an oversupply of money–that’s what the economist mean when they tell you that inflation is a “monetary phenomenon.”
Why do you think oil and food prices have been increasing so fast in recent years? Is it because of the increase in m2 or m3, or maybe because of increasing demand from the developing world. The former would be inflation. The latter is an increase in our cost of living for reasons the fed can’t really do anything about.
“3) Why does the Fed Focus on the Core rate, and not the actual rate? What are the Fed policy repercussions of this?”
Because the fed is trying (among other things) to control inflation, not the cost of living (which is approximated by the headline CPI).
Again, the key here is that it’s not the fed’s job to ensure that our standard of life improves. That’s the job of all the scientists, engineers, capitalists and workers out there. All the fed is trying to do is to prevent inflation–again, that’s an increase in the money cost of goods due to an oversupply of money–or deflation from interfering with that process.
Estragon: “Quite frankly, the people being hit with inflation currently have a limited ability to do much about it…”
Those are fighting words to the fine folks at AARP and their rapidly-growing constituency. What do you have to be, 50, now, to join? Yikes.
Woodshedder: “GN, do you propose the COLA is adjusted down when the All Items report goes into negative inflation?”
Perhaps. If you could actually demonstrate to COLA recipients that their total cost of living, year-over-year, went down. Highly unlikely with current monetary policies in place, of course.
I guess my point was just that inflation EXPECTATIONS are most important. And at some point those will be driven by EXPERIENCES (true or perceived) rather than BLS-generated numbers. The Fed is keeping things loose, hoping expectations don’t start ticking up, but my take is that they have (gold being the obvious tell).
«confusing “changes in the cost of living”–which is approximated by the headline CPI–with “inflation.”»
The changes in the cost of libving are also not the same thing as the changes in the standard of living. Substitution effects drive that difference. For example if suddendly steak and beer prices went up ten times, and people on a fixed budget ate just bread and water instead, te cost of living for them would be the same, but their standard of living would have plummeted.
«Inflation is an increase in the money price of goods and services arising from an oversupply of money–that’s what the economist mean when they tell you that inflation is a “monetary phenomenon.”»
That’s the sort of definition that ignorant and dumb first year students are taught perhaps, or that propagandists use — because it omits a whole lot of rather important things, like velocity of circulation, and the many different types of ”money”, that one learns in the second or third years (hopefully).
As that buffoon from Chicago should have said, inflation is always and only a political phenomenon, arising when the party of rising prices (debtors, owners of real assets, rentiers, …) gets more power than the party of price stability (creditors, owners of bonds, pensioners, …).
“If the core rate is a dramatic misrepresentation of actual inflation, what can the informed investor do to leverage that “disconnect” to their own advantage?”
That’s simple. Buy gold.
from gustav:
“Why do you think oil and food prices have been increasing so fast in recent years? Is it because of the increase in m2 or m3, or maybe because of increasing demand from the developing world.”
You didn’t answer your own question… so I’ll just note the extremely high correlation between oil and food prices around the world and the growth of m2 & m3 around the world… and that growth has been going on for decades and decades.
Perhaps you should visit the long term inflation page at my site and view the oil and various food items charts – and in the context of the cycle of hard and soft assets noted on my key stats page.
http://www.NowAndFutures.com
Woodshedder,
I just assumed because of your focus on Panzner that he was getting on your nerves with his book.
You folks are missing the really BIG picture (pun intended):
This has been a massive wealth transfer from consumers and savers to hard asset holders.
Real estate, gold, timber, metals of all sorts, commodities, equities, even water — they have all gone up in price, enriching their holders (who are mostly in the top 10%).
Meanwhile, the discretionary dollars of the bottom 90% goes less and less far.
Im surprised DeLong doesn’t see this . . .
«Why do you think oil and food prices have been increasing so fast in recent years? Is it because of the increase in m2 or m3, or maybe because of increasing demand from the developing world. The former would be inflation.»
One commentator was saying that the Fed was being easy with money in the past several years to accomodate the rise in the price of oil, and not viceversa.
The idea is that the leverage of the oil producers has increased, and the increased outflow of dollars from the USA for oil payments would be deflationary, so the Fed eases to make the adjustment less painful.
«The latter is an increase in our cost of living for reasons the fed can’t really do anything about.»
But distinguishing between ”cost of living” changes caused by changes in the terms of trade and ”inflation” caused by too much money is rather difficult and artificial — for many reasons, not least that measuring the quantity of money is very difficult (there are many types of money) and anyhow there is velocity and so on.
Also, and rather importantly, generalized expansion of the money supply *creates* changes in the terms of trade, both nationally and internationally; there is no such thing as an expansion in the money (whatever that is) supply that is price-neutral. If definitely favours certain parties compared to others.
Anyhow whatever happened in the past 20 years has been far from a generalized anything; relative prices today are very different from 20 years ago, and even absolute prices have become very different, many have even fallen, while others have risen a lot.
«”If the core rate is a dramatic misrepresentation of actual inflation, what can the informed investor do to leverage that “disconnect” to their own advantage?”
That’s simple. Buy gold.»
Gold is a real asset, but it is a very peculiar and strange one that carries with it a lot odd risks.
«This has been a massive wealth transfer from consumers and savers to hard asset holders.
Real estate, gold, timber, metals of all sorts, commodities, equities, even water — they have all gone up in price, enriching their holders (who are mostly in the top 10%).»
Very true, and the ”inflation party” has made out like bandits.
The story of the past 1-2 decades is that insiders, those with access to the biggest money firesale in living memory, have borrowed as much as they could to buy real assets. Especially real assets commanding monopoly positions with lots of pricing power.
One of the most obvious examples has been the appetite of investors for toll roads. They have been buying from states and governments local monopolies like that with a many-sharp-toother smile.
USA companies have been borrowing whatever they can in cheap, ultra-low-real rate, dollars, and investing in foreign factories, foreign currencies, foreign property like crazy. This has also driven a lot of outsourcing, as zero or negative real interest rates have resulted in free capital, allowing big corporates to ignore the sunk costs in USA plant and factories and invest, essentially cost-free, in new state-of-the-art highly capital intensive production in China and India, to the ridiculous extent that they now export software and routers instead of the traditional products of labour-rich, capital-poor countries, from textiles to toys.
Warren Buffett has even been shorting the dollar for years (and he is now, thanks to Helo Ben, making a lot of money on that).
Suck it, wage slaves. :-(
(blissex) “Anyhow whatever happened in the past 20 years has been far from a generalized anything; relative prices today are very different from 20 years ago, and even absolute prices have become very different, many have even fallen, while others have risen a lot.”
As I noted above, check the 200+ year history of the soft vs. hard asset cycle. Then check my long term inflation pictures on the link that BR so kindly provided.
There is way more data & facts out there than you’re perhaps aware of.
http://www.NowAndFutures.com
I should correct an error. I stated above that the gasoline futures contract change had been debated regarding its effect on i-n-f-l-a-t-i-o-n prior to the mid-term elections.
I was obviously wrong, because the suspected reason (I’m not saying I agree) was the direct effect on gasoline prices, not inflation, per se.
However, I stand on the thrust of my comments since the big drop in CPI (including energy) resulting in its convergence with core during that time (ex-energy) is the source of Barringo’s specific objection.
Too, the administration was prompt to emphasize at that time its attainment of sustained low inflation as part of its campaign for Congressional seats.
Finally, Woodshedder, it appears that Panzner merely cooperated with Barringo by providing a valuable assistance, even though the two of them hardly agree about inflation. So, you don’t have to be paranoid about ulterior motives. Regardless of your position on the subject, one of them agrees with you and one doesn’t.
FYI, I’m with Panzner. And, if Barringo wants to play the cluck-cluck game, he knows where to find me.
Ecletic, I haven’t read his book yet, but I will, soon.
The bottom line is inflation is our future, we must work around it. The market is a buy with inflation. It makes my bones ache to think about it.
“Be not too tame neither, but let your own discretion be your tutor.” Shakespeare
Woodshedder,
I haven’t read it yet either, but I don’t think I’ve incorrectly referenced anything Panzner has said, directly or indirectly. You can preview it here with an interview (audio, transcript or both) of Panzner (I have no affiliation with Panzner, or with TBP except as a comment contributor, and no affiliation with the linked source):
http://www.financialsense.com/Experts/2007/Panzner.html
One of the warnings in his book is about the potential for eventual hyperinflation. Well, you can’t get from 2% core to hyper without some sort of dramatic financial tumult. It’s just that Panzner seems to expect a serious deflation first, prior to a potential governmental response to the crisis by extravagant use of failed monetary policy leading to a Weimar type hyperinflation. BTW, I’m not upstaging his book. The interview above has been posted for several months, and Panzner has spoken of the book’s contents often as well in other public appearances.
You can read my theories on this blog and see that I define hyperinflation not as a pricing phenomenon run amuck, because hyperinflation is in a sense NOT inflation as we commonly understand the term at all, but rather it is the result of a loss of Monetary Obedience. I differ with Panzner’s worst case in this regard – his whole book, according to him, presents the worst case, financial and political – because I expect the U.S. would preserve its power to command Monetary Obedience even in some worst case scenario.
Hyperinflation is associated with failed governments, but not specifically because of failed monetary systems caused by governmental collapse; Confederacy during the Civil War, Weimar Republic (after the collapse of WW I Germany and, according to Keynes, largely because of the Treaty of Versailles). The rapid reinvigoration of Japan’s and Europe’s economies after WW II occurred because somebody eventually listened to Keynes’ admonition of what the Treaty of Versailles had done to Weimar Germany. The practical realization of this resulted in The Marshall Plan:
http://en.wikipedia.org/wiki/Marshall_Plan
I’m optimistic that the financial system will remain intact, even in the worst case. But, the key to preventing a collapse is to meet the requirements to cure the system’s problems now, before they ratchet to the point that they can only be corrected by a type failure that history has proven can even lead to revolution.
Our biggest problem is that our leaders in government are letting us down by allowing their constituency to lock them into playing mindless games of NIGYYSOB (Now I Got You, You S.O.B.!) rather than facing our problems head on.
Sometimes there are bright moments of hopefulness. For example, Bernanke (indeed, earlier, Greenspan too) has preached a sermon to the administration and to Congress regarding both the mortgage securitization industry and the coming storm of fiscal shortfalls, yet they only are able to respond in crisis mode after a near collapse of the financial system got their attention because of subprime.
Too, recently, Barney Frank and others have come precipitously close to an ultimate potential solution. Although the government has no right to abrogate contracts, they do have the authority to install an effective system, promptly, that will allow market participants on both sides of threatened mortgage syndications to voluntarily enter into agreements to reorder the terms of their prior contracts themselves, without the accompanying extreme expense of using eviction, repossession or bankruptcy laws.
Using an ombudsman of high reputation and administrative talent for heading up this effort is also a useful and practical overture. Do it NOW, before it’s too late. To my mind it can be accomplished with an absolute minimum of taxpayer assistance. Putting the system in place NOW will make dealing with future problems a lot easier if this housing situation worsens to an even larger extent than the most pessimistic commentators might suggest now.
Let’s be honest. The word Armageddon evokes in one thoughts of a terminal condition, one not simply limited to human malaise but to ultimate destruction. As I’ve said, I haven’t read the book yet, but I know Panzner offers ways to plan for Armageddon in the book. In doing that constructive thing, he’s really brushing the subject with a sort of optimistic paintbrush, so let’s forgive him the title and wish him luck on his sales. If we truly get Armageddon, he won’t get to enjoy the money, ha!
Armageddon as a philosophical concept related to our socio-economy is not something that can be easily digested by picking up Panzner’s book at the bookstore and reading it over a double café latte at the food court in the mall, especially after pounding one’s way through vast crowds of rabid consumers shopping their way to early Christmas completion… under barely-past-Labor Day-hung Festivus For The Restivus tinsel.
It’s something that responsible leaders s-h-o-u-l-d frighten themselves with, in the cold stark reality of their imagination. It’s the only place they can find temporary independence and the courage to structure solutions to problems seemingly insoluble. We need intellect, conviction and action… not mouth. And we need those things NOW… and not just about the problems in the housing market.
Had a meeting last night with my local state delegate about the upcoming election. Three little points stuck out:
1. The State of Virginia is expecting another 23% increase in the cost of medical care this year. Has not been below 20% in the 6 years he has been in the legislature. Is growing to a massive part of the entire state budget with no end in sight. No real way to control the costs for the state since the Feds are just cramming all this down the state’s throat. So no inflation in medical care.
2. Road building costs have more than doubled in the last 5 years per mile and maintenance costs have nearly doubled as well. No inflation in road building, a major state function.
3. State is facing dramatically increased costs for everything that it does. Virginia has been voted the best run state 2 years running and we are still in a deficit. Firing a couple hundred state employees to balance the budget. And this is when revenues are still rising. If we actually do slip into a slowdown, there will draconian cuts in state services or taxes will have to increase a good bit.
So as you can tell, there is inflation so please stop spreading that lie.
Thanks and keep up the great work.
Robert Kuttner testified in front of the House Finance Committee, and he compared the conditions of today with those that existed in earlier times – he faults deregulation. This comparison is interesting:
“Although the particulars are different, my reading of financial history suggests that the abuses and risks are all too similar and enduring. When you strip them down to their essence, they are variations on a few hardy perennials — excessive leveraging, misrepresentation, insider conflicts of interest, non-transparency, and the triumph of engineered euphoria over evidence.”
I don’t think you can produce a more apt phrase than “the triumph of engineered euphoria over evidence.”
In a recent economic discussion paper, Will Monetary Policy Become More of a Science?, Federal Reserve Governor Frederic Mishkin reviewed the progress economists have made in monetary theory and policy in recent decades. He had some good news for central bankers:
I did an analysis of CPI on my blog on 9/9 which may be of interest to you.
http://capitaf.blogspot.com/2007/09/how-core-cpi-number-is-poor-model-of.html