Barry Ritholtz Does Not Seem to Understand the Purpose of "Core Inflation"
Barry Ritholtz Does Not Seem to Understand the Purpose of "Core Inflation"
The Federal Reserve's mandate to maintain price stability requires that whenever significant inflation threatens it is supposed to hit the economy on the head with a brick: raise interest rates, and so discourage investment spending, lower capacity utilization, raise unemployment, and so create excess supply. The Federal Reserve would rather not do this unless it has no other option. If the rise in inflation is thought to be (a) transitory and thus (b) self-limiting, the Fed would prefer to let sleeping dogs lie rather than hit the economy on the head with a brick.The Fed cannot, however, just say "we regard this rise in inflation as (a) transitory and thus (b) self-limiting, and so are going to let sleeping dogs lie." A Fed that does that quickly loses its credibility as an inflation-fighter, and a modern central bank with no inflation-fighting credibility is in a world of hurt.
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." If the Federal Reserve concludes that the current rise in inflation is transitory and self-limiting, it can point to the core inflation number as a principled excuse for not hitting the economy on the head with a brick.
The Fed uses the concept of core inflation not because it doesn't recognize that food and energy prices are not rising, but because it doesn't want to hit the economy on the head with a brick when it isn't necessary just because it has to demonstrate that it is one tough mujer.
If any of the bears are so confident of the science behind their logic, they should be willing to submit a research papers to well known economics research publications, propose a alternative coherent theory and be willing to defend their logic based on science and statistics rather than rhetoric flourish and 50000 posts which reiterate same "belief". Personal beliefs and wrong understanding of concept is not science, even though publications like Wall Street Journal and Business Week for whatever reason allow such pseudo science without challenging it.
Any such research paper if it proves established and documented economic science and theory as wrong will win a Nobel Prize.
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22 comments:
Pradeep, many good comments have been posted over there. Unfortunately, the only ones that receive any attention are ones that continue in the perma-bear thinking. Seldom will any comment, although it may be coherent and sound, receive any attention if it does not bash the Fed, the President, Greenspan, Dow Jones Index in inflation adjusted dollars, and so on.
It makes for a lot of good blog traffic for Barry, and a good hang out for the psuedo-economist perma-bears. So basically, it is for entertaiment purposes only.
Funny how people sometimes choose to trust what's too much work to understand. These academics are full of BS. I have a Ph.D. and know the racket quite well.
The Fed has been incapable of hitting the economy with a brick since Volcker. The market knows it, and has taken full advantage. The core CPI is the biggest fraud going, perpetuated on retirees and savers who don't know better.
A broad brush arguments like PhD is a racket or academics do not run money, so they don't understand economics is just a attempt to divert the issue and further show ignorance.
We are now in a scientific era where there is an established method and process to establish an alternative theory or to refute an existing theory. That is hallmark of science.
If someone is attacking established theories either that person does not understand and has not studied the field and is just talking about his belief not supported by facts or the person is proposing an alternative theory or explanation of phenomenon. In the second case such person would be welcomed by all scientific minded people. All scientific minded people are open minded willing to listen to a well argued, coherent alternative theory and test those hypothesis or theories. That is how the society progresses.
When arguments are weak, lung power, name calling, skillfully changing the issue are common behaviors.
I agree with t. and shold listen to Ron Paul, specially when he ask The Fed question abut he subject and see how Bernake tap dance
Appreciate being allowed to voice my disagreement here.
Before you go and trust academics too much, be aware that the group-think and politics in these places is unbelievable.
The mid-19th century socialist group-think in academic circles is among the costliest examples. Whole countries an countless lives were destroyed by it. There are many stories in science on how unconventional thinking took forever to come out of the wilderness. The ulcer bacteria theory is one recent example.
For a current example, look at the slow shift in the Autism debate. After ridiculing any link to vaccines, the establishment is now starting to consider the possibility there is something wrong here. Academic group-think is alive and well, despite their best intentions.
The inflation of food costs is more than transitory, it is increasing pressure on food manufacturers (see Tyson and Pilgrim's Pride releases on the spectacular price jumps), margins at restaurants are plummeting, and the consumer is generally seeing very large increases in things they buy each and every day, especially when wages are not rising along with these added costs.
It has always been suspicious to me the many times that the choice of CPI or core CPI used as headline. We've seen this recently - core CPI is down but overall CPI is up: Headlines read "inflation is down". Core CPI slightly up but overall CPI is down (due to fuel, not food): "inflation tamed".
Fuel costs go up and down. Food costs, in large part because of ethanol demand raising costs of feed, which raises costs of chicken, beef, dairy, and so on, have seen a sustained and marked increase. And this is an increase that the average consumer truly feels on a daily or weekly basis.
While some items in the core CPI have had their prices mitigated overall, it remains to be seen whether ignoring a sustained increase in food costs will in fact *not* spill over into these core items.
There is definite merit in being cautious and not "hitting the economy with a brick." These pressures on food could be mitigated over time by a decrease in corn/ethanol demand. If that ever happens.
In the end, I simply disagree that questioning inflation readings or seeing dangers in hyper-excited markets means you are an unsophisticated perma-bear who knows nothing and is driven by pure emotion, as opposed to a perma-bull.
I've been a stockbee fan for a while. Thanks.
All the factors you quote for food price going up are temporary factors that may reverse themselves later.
Is a policy decision based on such trends appropriate way to frame policy.
A well argued and well reasoned and coherent bearish position any rational person respects on the street.
But when the position turns to imputing motives to policy makers, claiming normal survey methods are manipulated, or to claim that theory and reality does not match or academics do not manage money so their theories are wrong is a clear sign of psudo scientific thinking. When it is done consistently it shows ignorance and cognitive bias.
Strong and coherent arguments stand on their merit when challenged.
As Barry blankets the media with his analysis and becomes a celebrity, obviously academics and others who understand economics will challenge those theories and assertions. As long as someone does it on his own blog it is ok but when mainstream media starts carrying such analysis. It will be scrutinized and questioned.
T
I have very good understanding of the politics which happens in academic and research institutes. I have several past students doing PhD or ex colleagues doing PhD. Part of family is involved in major path breaking medical research.
Given all those abberrations , in most research setting scientific views are respected and coherently argued. The comments on the original blog and response to it clearly demonstrates how childish and churlish those arguments being put forth are.
If there are well reasoned and coherent arguments they stand on their own.
The underlying reason for using a core CPI is clear. It's not wise to be making decisions with drastic effects based on something that fluctuates rapidly. But the question at this point in time is whether these excluded items really are ever going to trend back down or trend back down in the same speed they have been able to in the past. Global pressures are adding to demand for food and for energy and so if the only way for these price pressures to decrease is global in scale, should these items really be excluded. Is anyone ever going to look at these and decide that they are no longer transient given a globalizing economy?
t.- your point about autism is well-made. However, I think it makes the opposite point that you want. You again paint with a broad brush yet do not provide any scientific facts. Reading what you wrote, one might think that researchers have began to uncover a link between autism and vaccines.
Actually, all the research (and my house is full of it right now) shows no link. In one article I just finished reading, there has been no MMR vaccine in Japan since 1993, yet autism rates have continued to climb, even after the program was terminated.
The point here is that within economics, there is science. Pradeep's point is that rhetoric has taken the place of science. Much as you speak of autism and provide no research, the discussion of Core CPI / All Items CPI is generally bereft of any real science.
That's the question, are they still temporary or transient now? How long will it be for these price pressures to diminish? Is the time scaling still the same such that it is appropriate to disregard them and the effects of the increased prices. This is a big question that leads many to doubt whether the core CPI as it is now is current and correct. There is no doubt that transient and limiting items shouldn't be the basis for large policy decisions in general, however.
If you look at past , every time they start going up, we tend to believe that the trend will never revert. But high prices is such a major incentive that production increases or substitutes appears.
I was recently in India talking to some grain traders, two years ago price of a particular pulse used daily in India skyrocketed and went up by some 600%. All kinds of theories were offered as to why this will continue, not reverse in near future and so on. What happened after a year was Turkish grown pulse entered the Indian market because of price difference. The prices crashed. Farmers had record planting of the pulse expecting high prices. The new crop further drove prices down. Now the prices are below historical norms. Food prices are extremely sensitive to such factors.
I may be the dumbest one here,but i thought inflation was the erosion of the dollar purchasing power measured by cpi....what about cpi is being measured by stuff that wont go up a lot? I seen a fed employee at wal mart login the price of a tomato(why a tomato, hopefully someone can explain me why?).Now i buy 2 tomatoes for a dollar one week. the very next week went on sale 4 for one dollar, fed employee log the price...That means my core inflation went down 50 % ...woo, im rich. Its a scam, fed takes stuff like that to make them look good, but its a scam. a lot of countries says that we are in a recession because of this, because we are not taking the real reading...if you take inflation reading like japan,you will see we are in trouble...Again, i agree with t...garbage in, garbage out, just look at money supply and the dollar value(35% decline since 2002)
I have to agree with most of the posters here: Core CPI ex-energy makes sense to take out short-term variations in the price of oil. But what we have now is oil in a 9-year secular uptrend from $18/bbl to $83/bbl. Instead of ex-energy, why didn't they simply smooth the oil price series?
Very interesting conversation, if you take a look at long term charts of commodities - prices ALWAYS mean revert in the long term. As prices rise, substitutes are found. Not to say oil prices won't goto a $100 or even $200 before a suitable replacement can effect the price. Grain has had a huge move in part due to ethanol and in part to a huge drought in Australia. These prices will likely revert. Corn is moving on demand for ethanol, most people agree that ethanol is not sustainable. If you look at companies like Monsantano, they are dilligently working on new seeds that yield more corn per acre, you can see the dynamics at work already.
I have my concerns about using substitution for food.
Aside from that, if this most recent energy and food increase is indeed simply an inflationary spike that will eventually revert to the mean (an inflation-adjusted mean? what does that really mean then?) either through substitution or external causes, in the meantime it has a great chance of affecting the core inflation by the sustained rise in prices. Corn is moving on demand from ethanol that can be reverted and global demand that will not likely be reverted unless people stop using grains.
Jobs are being lost, corporate profits are disappearing, people are losing money because of the sustained increases in price of these excluded items. This is why so many people have a hard time believing the headlines that inflation is tame or non-existent. It's anecdotal, but real and that's a root of complaints. My wife is not a pseudo-economist perma-bear but she scoffs at the news about inflation because she does the shopping and sees the budgets and the effects of inflation.
I would argue to DeLong that cutting rates is just as much "hitting the economy with a brick" as raising rates are. The effects can be just as damaging if incorrect.
Economics is really more of a pseudo science than actual hard science. Economists(especially in academia) generally come from different schools (Keynesian, Austrian,Marxist etc...) with competing theories on growth, inflation, et al. For the most part, none of these theories can be proven in experiments using the scientific method.
Those who do not have formal training in economics always make such arguments.
If one learns economics as science no matter which country you learn in same theories and same concepts are taught.
When challenged economics theories can be defended using logic.
One of the other arguments put forth by most "practicing " managers is economics in academia do not understand reality. This is classical propaganda technique used by those with no formal education in the field.
"Red Meat Analysis" as practiced by commentators is designed to appeal to lowest common denominator. It uses personal life stories or limited data to appeal to base. When challenged by scientific minds or academics, it appeals to emotions, imputes motives, uses rhetorical flourish or changes subject.
Most of the comments are using their personal life situation to draw macro economics conclusions. Science in all fields has moved beyond that many years ago. Science relies on hypothesis building, testing, offering explanations. Building models developing theories.
Rational arguments are hallmark of scientific thinking "red meat arguments" using "personal" cheese price data and personal "belief" about employment numbers and questioning substitutions are all layman arguments.
At one spectrum you have such "red meat analyst" at other spectrum you have people who study economics as science and have built models like ECRI which are based on valid , rational, scientific techniques and use same data and have demonstrated reliability.
The read meat analysis, conspiracy theories, selective parsing of data, playing to gallery is very popular, it builds a cult but it is not science and validity of such arguments should be challenged and vigorously challenged. That is how science and society progresses.
I still maintain my challenge, if such commentators have alternative theories besides just personal life stories to refute established theories in economics, they should publish and defend them. They would win a Nobel for disproving widely accepted theories. If that happens they might be appointed to Fed Chairmanship and then they can happily do what they preach and see the consequences.
As long as one does not take a personal experience and try to make it into an argument for macro-economic policy, but rather for asking reasonable questions that should have scientific responses, I don't see the need for the pompousness.
People losing their jobs as a direct consequence of sustained increases in excluded items is more than a non-scientific "belief" that they should be derided as uneducated and emotional for holding.
I was only asking a couple of simple questions that I expect do have some scientific response somewhere. What proof is there that the recent large increases in food and energy, driven by not only inflationary spikes that can be mitigated by substitution but also global growth that in some cases cannot be mitigated, are self-limiting and transitory? As I never claim to be anything more than an armchair economist, I assume there is something on this. Past performance is not a guarantee of future performance, especially in an evolving global economy.
Hey t,
Which study has established that vaccines have caused Autism?
A link to that study (not an article based on personal opinion but a routine research study) will be great. I will wait for your reply here.
Comments from the Dallas Fed on this subject:
Richard Fisher on Thursday said the increases in food and energy prices over recent years could represent “longer-lived trends rather than transitory blips”. If this was the case “the arguments made for excluding food and energy prices” from core inflation, the Fed’s traditionally preferred measure, “would be on shaky ground”. The Dallas Fed chief cited Bank of England chief economist Charles Bean, who argues that core inflation captures the benefit of globalisation and the rise of China in the form of cheaper manufactured goods, but ignores the cost in terms of upward pressure on food and energy prices.
Some other members of the Fed’s policymaking committee say they too are paying increasing attention to alternative measures of underlying inflation in the light of persistent increases in food and energy costs.
However, it [the Fed] continues to regard core inflation as an important guide to underlying price pressures. In practice, the Fed forecasts future core inflation and then adds an estimate for food and energy prices, based in large part on futures prices.
If the futures markets suggested the price of food and energy would rise significantly, the US central bank could aim for a lower core rate in order to achieve its desired level of overall inflation. But the markets do not appear to forecast they will rise by noticeably more than the general rate of inflation in other goods and services.
This is precisely what I was talking about.
i just got lost on this discussion, however this is my take; inflation is a monetary phenomenon by the fed due to fiat currency, is being under reported saying by the new method its 2.6%, if you take the cpi reading by the old way, its over 10%(wonder why).we are in a global economy, every other country is rising interest rates except US to combat inflation, but economies are interwined( i guess not including US). Again, core cpi a fraud, eroding savings depreciating money and transfering wealth
Never said studies established a link to vaccines.
This article expounds on what I alluded to.
http://www.nytimes.com/2007/10/09/science/09tier.html?em&ex=1192248000&en=9f36687fe8aef756&ei=5087%0A
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