Barry Ritholtz at the Big Picture Blog asks “Why Has Inflation Remained Low for So Long?”
Ritholtz’s article is a guest post by author Robert G. King titled “Inflation
in the Great Recession and Gradual Recovery: Surprises and Puzzles“.
Neither Ritholtz nor King ever answers the question. Instead, King
presents mathematical gibberish regarding the Phillips curve coupled with
visions of inflation dynamics, a new Keynesian model, and a long-term
expectations model.
Inflation Dynamics
New Keynesian Model
Long-Term Expectations
King notes that all three models failed to produce the expected results.
Three Misses
All three models miss on features of the quarter-to-quarter inflation
dynamics:
- The dramatic decline in inflation in late 2008 and early
2009
- The return to inflation averaging about 2% centered on
2011
- The low rates of inflation beginning in 2014 and
ownwards
King presents 24 pages of even more complicated gibberish followed by another
20 pages of charts references and other essentially unintelligible items.
He concludes “It would be useful for academics working on micro pricing to
help BLS create new pricing research series, both in terms of the design and
potentially in terms of development of algorithms that the BLS could simply
make use of each month.”
Truly Useful Proposal
If King wanted to propose something truly useful, he would have proposed
economists stop the economic nonsense.
Attempts to predict consumer behavior via mathematical plug-in equations
with dozens of assumptions, that fail to consider asset bubbles, debt
dynamics, and globalization pressures is beyond foolish.
It’s amazing these models are even in the ballpark, which of course
presumes reported inflation is indeed in the ballpark.
When the BLS tells us medical expenses are up only 5% from last year (more
in this in a subsequent post), we know upfront, without a shadow of a doubt,
the medical CPI component is vastly understated.
Moreover, the BLS’ models do not consider rising housing prices as part of
inflation. That is the same mistake the Fed made from 2003-2007 hiking rates
too little in the face of massively rising inflation.
Dissecting the Fed-Sponsored Housing Bubble; HPI-CPI Revisited
I touched on the subject of housing CPI on numerous occasions. Let’s take
a flashback look at my 2013 article Dissecting the Fed-Sponsored Housing Bubble; HPI-CPI
Revisited; Real Housing Prices; Price Inflation Higher than Fed Admits.
Comparative Growth in HPI vs. OER
From 1994 until 1999 there was little difference in the rate of change of
rent vs. housing prices. That changed in 2000 with the dot.com crash and
accelerated when Greenspan started cutting rates.
The bubble is clearly visible but neither the Greenspan nor the Bernanke
Fed spotted it. The Fed was more concerned with rents as a measure of
inflation rather than speculative housing prices.
Fed Funds Rate vs. CPI and HPI-CPI
The above chart shows the effect when housing prices replace OER in the
CPI. In mid-2004, the CPI was 3.27%, the HPI-CPI was 5.93% and the Fed
Funds Rate was a mere 1%. By my preferred measure of price inflation, real
interest rates were -4.93%. Speculation in the housing bubble was rampant.
In mid-2008 when everyone was concerned about “inflation” because oil
prices had soared over $140, I suggested record low interest rates across the
entire yield curve. At that time the CPI was close to 6% but the HPI-CPI was
close to 0% (and plunging fast).
As measured by HPI-CPI real interest rates were positive from mid-2006 all
the way to 2010, even when the Fed Funds rate crashed to .25%. That shows the
power of the housing crash.
Real rates went positive again in mid-2010 until early 2011.
CPI and HPI-CPI Variance From Fed Funds Rate
The above chart shows the “Real” (inflation adjusted) Fed Funds Rate as
measured by the Fed funds rate minus the CPI, and a second time by the Fed
Funds Rate minus the HPI-CPI.
Alternate Question
Barry Ritholtz Asked “Why Has Inflation Remained Low for So Long?”
I ask “Is inflation low? For whom? By what realistic measure?”
King apparently believes the CPI accurately measures inflation. I propose
it doesn’t. Medical CPI is a joke, and so is OER vs. housing prices. That’s
for starters.
Shadowstats goes
off the deep end in the other direction, with preposterously high measures of
inflation.
Missing Factors and Poor Assumptions
King fails to take into consideration aging boomer dynamics, student debt,
debt loads in general, asset bubbles, and all kinds of other pertinent
variables.
Besides, there is no such thing as a standard consumer basket. Someone
with kids in college has a far different basket than a retiree living on
fixed income.
Fundamentally, it is difficult if not impossible to measure inflation in
the first place.
There are all kinds of new gadgets, household items, etc. that did not
exist even a few years ago. To counteract, the BLS makes assumptions
about quality improvements. The BLS also substitutes chicken for beef when
calculating food CPI.
Let the Market Determine Rates
Standard measures of inflation fails to measure money supply,
housing, and asset bubbles. They do not need to be improved, they need
to be discarded.
My own definition of inflation and deflation involves money supply and
credit marked-to-market. The Fed ought to be worried about asset bubbles, not
routine price deflation.
Given that the Fed has blown asset bubbles of increasing magnitude over
time, the flaws and errors suggest we do something different.
I am confident there would not have been a housing bubble, at least of the
magnitude we had, if there was a Fed holding interest rates too low, too
long, on absurd notions that “inflation is low”.
The CPI system of measuring prices is a complete joke. Rather than
attempting to improve it, I have a better idea, get rid of the Fed and let
the market determine interest rates.
In a foolish attempt to defeat routine consumer price deflation, the Fed
has sponsored yet another asset bubble that will bring about damaging asset
bubble bust and credit deflation. The BIS would agree.
For discussion, please see Historical
Perspective on CPI Deflations: How Damaging are They?
Mike “Mish” Shedlock
