Inflation: Not a Problem
Posted: November 18, 2010 Filed under: The Media SUCKS, U.S. Economy | Tags: CPI, inflation, logical fallacies, PCE, PPI, stupid conservative idealogues 36 Comments
Core Inflation: the Japanese Stagnation compared to the U.S. Great Recession via the SF Fed and Mary Daly.
This is one of the posts that I want to use to debunk that stupid cartoon that I keep seeing on Facebook. That cartoon also brought on many comments that come under the classification of ‘fallacy’. A fallacy is a type of error in reasoning. I have to identify the common ones we see when folks discuss economics when teaching economics. The fallacy associated with comments I see about inflation recently come under the heading of unrepresentative samples. People make hasty generalizations that because one thing they experience is true, they can generalize that experience to everything.
These inflation fallacies pretty much fall into line. It’s like, I went to the grocery store, I’ve been keeping track of what I’ve been paying for meat and that’s going up. Therefore, inflation must be a problem. (The other one I’ve been hearing is about rising taxes which I’ll debunk in another post. Let me stick to this one first.) So, first, inflation is not just the increase in one or two prices, it’s the increase in the average price levels in a country. That means everything. Not only the meat at the grocery store in your town, but the average prices every where in the country for the price of meat and everything else. While, your meat is going up, I’ll raise you that pound of brisket and tell you how cheap it is to buy a HD TV or a normal pair of jeans these days, or for that matter any apparel. But then, I’d just be engaging in the same fallacy. So, instead I’ll go with defining inflation, showing you how we measure it as economists, and then letting you look at the numbers. That graph top left is a good illustration of the average prices in the country as measured by the CPI or Consumer Price Index through September. Average Prices as measured by this index–which is the index quoted in that silly cartoon–show a distinct downward trend. This indicates deflation not inflation.
That’s just the CPI which actually tends to overstate prices which is why economists and the FED don’t use the CPI to gauge inflation. It’s been discredited since the 1980s as having distinct biases. Part of this is because it only applies to retail prices. Another part is that it uses a basket of typically purchased consumer goods and until the basket is changed, the weights of each price in the index reflect the basket. For example, if the basket still had VCR players in it, that would be a problem. The basket has to be re-arranged ever so often or it doesn’t reflect the actual buying patterns or budgets of typical U.S. consumers in the top 40 cities where the prices are collected by the BLS. The Fed doesn’t even collect the inflation numbers, the BLS does. The BLS also collects the unemployment and jobs market information. The FED reports them in addition to the BLS and uses them for their studies.
The three main inflation indexes most people hear about are the CPI(the Consumer Price Index), the PPI (the Producer Price Index) and the GDP Deflator. The CPI only tracks retail prices. The PPI tracks whole sale prices. The GDP Deflator tracks and weights all prices by what they represent of the current period GDP. It’s the most broad-based and least biased because of that weighting system instead of the basket. It reflects “average prices” of everything in the country. Most economists use the GDP Deflator unless they are specifically interested in how prices impact households.
The FED uses the PCEPI or Personal Consumption Expenditures Price Index to measure inflation for households. It is less volatile than the CPI and looks at ‘core inflation’. It is also a chained index which means there is no fixed base and it looks at inflation from quarter to quarter. The other indexes use base years which is why you typically see things like REAL (meaning it’s deflated) GDP in 1984 dollars or 1991 dollars. That means those measures are tied to the purchasing power of the base year of the index.
The FED uses the PCE–and has since 2000-which has indicated about 1/3 less inflation than the CPI. This is because of those statistical biases we mentioned above in the way the CPI is calculated (not a chain index) and in the way it uses a basket. The reason that the FED pays attention to “core” prices is because of seasonality that is present in things like food prices and gas prices. Food prices tend to change based on season for obvious reasons and people will substitute in and out of products that are lower in price and ‘in’ season. The CPI does not reflect this because of its use of the constant basket. It has a ‘substitution’ bias.
Economists detect and detrend series like these for seasonality. The biggest example of seasonality is in retail sales which typically peak extensively in November and December. It’s not part of an overall trend in the series. It’s just a recurring blip that we can account for by figuring out what magnitude it tends to be each season.
So let me go back to FedViews and an article over at Mark Thoma’s Economist’s View and talk about why inflation is not a problem, even though the meat prices at your market may be. Then there’ this from the Clelevand FED’s expectations of future inflation today.
The Federal Reserve Bank of Cleveland reports that its latest estimate of 10-year expected inflation is 1.50 percent. In other words, the public currently expects the inflation rate to be less than 2 percent on average over the next decade.
The FT puts this in perspective.
Expected inflation over every time horizon longer than six years is now at its record low in the period since 1982 that the series covers. Expected inflation over the next ten years is now down to 1.5 per cent per annum.
The Cleveland Fed index is not the last word on inflation expectations but it is certainly reason to think that those QE2 = hyperinflation fears are somewhat misplaced…
Mark Thoma responds to an outrageous letter by a bunch of miscreants at the WSJ that have the audacity to scare people with inflation fears. It links to this “Open Letter To Ben Bernanke” and includes such ‘distinguished’ economists as “William Kristol, Editor, The Weekly Standard“. Actually, the signatories aren’t distinguished economists at all. They’re mostly political hacks and conservative policy ideologues.
I doubt the invisible inflation vigilantes will change their tune, but it’s hard to find evidence of inflation worries in the data. If anything, markets are reassessing the Fed’s ability to stop disinflation.
You can also see that Paul Krugman has disinflation concerns and he has a nifty graph up also. There is no inflation, there is deflation or disinflation.
The people who put out that cartoon also fall under the heading of ideologues and miscreants. The cartoon uses cute little funny speaking creatures to lead you into logical fallacies. You watch them and think, why yes this must be true because I just paid more for a pack of pork chops last week when the price most likely reflected the hog cycle. (Yes, hogs have gestational periods and some times even the best farmers don’t plan pig pregnancies at opportune times for household demand.)
So, I hope this gives you enough information on inflation to know that it is not a problem for the country. You really don’t want me to make you do the underlying calculations to all these indexes, but if you want to torture yourself, any Principles of Economics textbooks will put you through the paces. Oh, and don’t buy used cars or the Brooklyn Bridge from any of the shiesters who signed that WSJ editorial or any of them that put out that silly cartoon.
Update: Here’s some data on State Revenues from taxes even though I said I’d wait for another post to debunk that portion of that silly little cartoon. I’ve already explained how quantitative easing is not printing money, but I’ll do it again shortly because the blasted cartoon is getting more steam. It’s like some stupid chain letter now!
The data is from The Nelson Rockefeller Institute of Government at NYU-Albany and it shows how revenues from taxes are way down from the pre-recession period although slightly up this year from last. That includes all forms of taxes taken in at the state level. You can see if your state’s tax revenues are up or down in a Table 3.
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We had inflation in my old country and I know what you mean. It doesn’t feel like that here. Every time gas goes up here I start to think it will ripple to other prices but it doesn’t. Although there was a period in I don’t know if it was 2008 or 2009 when it felt like gas AND wheat had gone up and I thought we would get into an inflation spiral.
The problem we have at the moment is the huge drop in demand and that causes prices to go do overall. That’s why I can’t understand why we can’t get decent fiscal stimulus because it’s so obvious. I think that’s why Bernanke is trying the QE2. Because we have spineless fiscal policy makers and a group that have no clue about facts on the ground, only partisan policies and ideology.
Drop in demand is because people are either unemployed or scared that they will be. We should have a jobs guarantee.
Won’t happen any time soon without some kind of worker’s protests here or more labor unions. The big Corporations control everything these days.
Today we were out and about doing errands. Saw a homeless person in the middle of my little town. There’s never homeless people here; the town has previously been too small (about 3k population). But not now. It was a woman, middle aged, and her dog. About broke my heart.
I just also wanted to make a point of saying that there are prices increases in each market–that would be a microeconomic issue that occur–but inflation is a macro issue period because it’s all prices across the board, even if you look at just consumer prices the majority of them aren’t going up and the CPI includes food, housing, education, communication, and medical costs. There’s not enough increases in any one of those to offset the decline in prices in the others. And remember the CPI is weighted by what consumers would buy in terms of a budget. The prices are weighted by how much the item would comprise of a typical consumer budget. So, the percentages are important. Food and medical care and gas are all in the CPI. They do separate the consumer prices indexes into core and then core plus “food and energy costs” because food and energy costs are impacted by a high degree of seasonality.
Here’s a chart that breaks down the CPI by rigid or sticky prices: those things that don’t have price changes a lot, and those that are more flexible or are more likely to go up and down a lot. Core prices don’t include food or gas. Economists know that they can bounce around a lot and some of that is seasonal so they are reported separately. This is a FED chart so you can see that the FED tracks all prices relevant to consumers. You can see that about 16% of food and ‘energy’ prices–that includes gas for the car and energy for your home–can bounce around a lot. They’re considered very flexible which means they go up and down all the time.
Here’s the make up of the basket itself for the CPI so you can see the ‘budget’ or weights for each grouping.
Thanks, Dak, good explanation of why inflation is not a worry now.
It’s odd that the other indexes besides the PCE are the ones which are tied to the prices of a base year, but it is the PCE which is referred to as a “chained” index. Intuitively, one would think it was the other way around.
Excuse me, purchasing power of a base year.
it’s just the way the math is done.
Click to access CPI%20Example.pdf
Here’s a primer on how to calculate the CPI
http://www.frbsf.org/publications/economics/letter/2003/el2003-24.html
Here’s an article from an SF FED economist that goes into a little more detail on how the chain linking is different from the basket and base year approach.
Thank you, those were both very helpful 🙂
By accident I ran into ABC nightly news last night …I haven’t seen network news in years….But it was a revelation…I have been asking forever : how do they expect us to by their shit if they keep firing our ass ? Well thanks to Diane Sawyer’s romp in China I learned they don’t care anymore if we buy their shit…they are off to China chasing the 2 billion over there to buy it . And DS was all aglow about what they means for American STOCK HOLDERS when MacDonalds opens a new store every two days …OVER THERE…US workers get a lump of coal…Now we are really in the deep doo doo….We are like the first wife left for the younger model…wrapped in our cloth coat watching the new wife get in the limo with her furs….this ain’t good . What we had was: we buy stuff…now they don’t care. So that explains why we are being told to become ” competitive” with Vietnam’s labor scale . They are set to make us Mexico …without the nice climate
China needs to stop buying treasuries and bring its people into the modern world. They need to clean up their pollution and take care of their rural areas better. I have no idea why they continue to just hoard reserves. Now that Americans are finally spending and borrowing less-and I hope for good–they won’t be able to soak our growth off of us as easily. Americans need to watch from whom they buy their stuff.
China is letting its own center and peasantry go to hell in a handbasket ( that sounds familiar) …that’s not bright… and even if they weren’t…what is to prevent China from telling MacDonalds ( and other supposedly US companies ) at some point …” yo we are nationalizing your former restaurants . Bye now ” On top of all this is the environmental nightmare this hyper growth generates and which they are merrily sweeping under an increasingly lumpy carpet .
So let’s review:
China’s current policies are fostering internal revolt
They can take over US holding at any time
They are befouling their country at an amazing rate
Wow! Let’s trash the US and invest over there!/snark
I wonder if you could give us a similar tutorial on GDP. Reason I ask is that it seems to kind of a flaky number which includes finance and hamburger flippers in the same take as manufacturing. Another example is if material comes in a LA port and is promptly sent to Mexico, it counts in American GDP.
it is important to understand GDP, because they measure debt to GDP rather than current dollars. I have plotted the Debt to GDP and that curve bounces all over the place and is not a good measure of what is going on, given the flakyness of GDP
If you use real GDP instead of current dollar GDP, you have to decide which index to use to deflate the numbers. Actually, the way it is reported monthly is more like a cost of goods sold thing. It’s just simply accounting based and they look at whole sale steps first than retail. It is identified via sector codes too. Those are usually more strategic in the national income accounts. They’re looking to account for value added along the way in each step. You have to use deseasonalized GDP also. Most anything that has to do with sales has seasonality and that’s why it bounces all over.
OT, but a couple of hours ago the House failed to get the 2/3 majority vote needed to pass an extension of unemployment benefits (under suspension of rules). Twenty-one Repubs voted to extend, eleven Dems voted against extension. It’s going to be a bleak Christmas.
Yeah, I saw that. They can give tax breaks to the filthy reach but no one can be generous to the poor. What is wrong with this frigging country?
Apparently it’s the “new normal” (I hate that term with a passion) Christmas spirit.
Indeed…they usual can thousands around yule time as well…that has become a” new normal ” holiday tradition
Some how I have the feeling that the public does not have the understanding of what George Bush and the finance people did to this country.
Now that the safty nets are reaching their full term, the level of hurt is going to be felt more. Maybe the sense of outrage will become more pronounced. Maybe some demonstrations in the steet will happen
Dylan Ratgan just had a rant on how GM was treated properly and now is comming back. In other words managment was fired, labor, bond holders and suppliers shared in the down fall.
NON OF THAT HAPPEND FOR THE BANKS WHO RECIEVED BAILOUT
GM’s IPO would suggest otherwise.
Nice post Kat.
Btw did you read Alan Blinder’s op-ed in the WSJ a couple of days ago? He literally gave an Econ101 refresher as a public service. If you don’t have it, I could link to it here in the comments because I must have it somewhere.
Nevermind, I found it.
In Defense of Ben Bernanke
The whole thing is a must-read, especially for those clowns who signed that bizarre letter.
I couldn’t believe that letter. It was as if they came from an alternate universe! And thanks for that link!!!!
I think Sarah Palin considers her home economics courses enough to make her literate in economics. Not the same thing!!!
It does to an extent make her literate in microeconomics(which would be enough to run a state which also runs on a premise of a balanced budget like the average household budget). However, dollars to donuts she has no clue how macro works. It’s much more complicated then micro IMO. Comparing the two is like comparing addition and subtraction to algebra and trigonometry.
You really shouldn’t run a state on a balanced budget though. You should run a deficit in bad times and a surplus in good times that’s banked some where in a rainy day fund.
You have to pay for a WSJ subscription to read the whole article.
yeah, I bumped into that too … I let my subscription lapse.
I can’t speak to the basket being utilized but I do think whatever they utilize ought to be updated. For years everyone’s housing, health care, education and fuel prices have been increasing and we’ve been told there’s been low inflation. It doesn’t ring true to the average household and like it or not 90% of us use RETAIL prices when we purchase things. I remember hearing about food and fuel being volatile so disincluded but I consider that problematic because the average household can go without buying a VCR but they NEED food to survive. They NEED a place to live. They NEED to be able to get health care when they get sick. People can go without and will go without a new pair of jeans when the economy goes south. Perhaps they need to look at a basket that considers needs rather than a basket of wants.
They update the basket every couple of years to take into account new goods and also change in any shopping outlets. They don’t get price substitution very well though. So, it doesn’t always reflect the way that households will respond to sells or lower prices in similar goods. Like if you decide if you want one meat or another based on your budget and not that you eat steak once a week regardless. If that makes any sense.
Is a very well written post….. Thanks so much for information. ….Sorry for my English