Inflation: Not a Problem

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.