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Threat of Inflation: where is it?

phattonez

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Robert P. Murphy said:
There are several problems with the exclusive reliance on "core CPI" as a gauge of the tightness of monetary policy. First and most obvious, it is absurd to focus on the "core," which excludes food and energy prices. It is precisely these prices that are the most important for struggling households — and they are certainly not falling. According to the government's own figures, from September 2009 to September 2010, consumer food prices were up 1.4 percent, while consumer energy prices rose 5.4 percent.

Given that many households are either in financial distress or are terrified that they soon will be, is it really so surprising that consumers aren't spending gobs of money on things besides food and energy?

Another problem is that the Bureau of Labor Statistics can't very well document changes in product quality, which tend to mute price increases. To take an example offered by Silas Barta, the next time you open a cereal box, check out how flimsy the cardboard is; it was sturdier several years ago. I doubt that the government CPI figures take this sort of thing into account when telling us how weakly prices have responded to Bernanke's incredible bouts of money creation.

. . .

Besides nitpicking the construction of CPI data, there is the problem of focusing just on consumer prices in the first place. For example, according to the latest report of the Producer Price Index, in the last year prices for finished goods are up 4.0 percent, the prices for intermediate goods are up 5.6 percent, and prices for crude goods are up a whopping 20.3 percent.

But wait — there's more! According to economic theory, there's actually a very sensible reason to include asset prices when trying to determine the "cost of living." This is because most people don't want to live for a single day on milk and bread that they just bought at the grocery store. In principle an ideal price index would include prices for both present and future goods. As a convenient proxy, it makes sense to include asset prices when wondering whether monetary policy is causing the dollar to strengthen or weaken.

QE2 and the Alleged Deflation Threat - Robert P. Murphy - Mises Daily

Producer Price Index said:
On a 12-month basis, the intermediate goods index
increased 5.6 percent for September, its tenth consecutive year-over-year rise.

Producer Price Index News Release text
 

washunut

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If I am not mistaken, as constructed the CPI is 40% rent or housing costs. In this environment this will have a negative to flat impact on this number. Mt sense is that the Fed knows that deflation is a strawman that they are using. My sense is that they feel that asset prices, houses, bonds, etc as well as incomes are inflated in the U.S. compared to Asia. Their formula seems to be to depreciate the value of the dollar enough so that prices do not have to fall further and put the banking system into another tailspin.

The sad truth is just what you mention. The hardest hit are the poor who have less of a chance to protect themselves. Next worse off will be retired folks on fixed incomes.
 

Lord Tammerlain

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If I am not mistaken, as constructed the CPI is 40% rent or housing costs. In this environment this will have a negative to flat impact on this number. Mt sense is that the Fed knows that deflation is a strawman that they are using. My sense is that they feel that asset prices, houses, bonds, etc as well as incomes are inflated in the U.S. compared to Asia. Their formula seems to be to depreciate the value of the dollar enough so that prices do not have to fall further and put the banking system into another tailspin.

The sad truth is just what you mention. The hardest hit are the poor who have less of a chance to protect themselves. Next worse off will be retired folks on fixed incomes.

The CPI uses something called implied rents for the cpi, it tends to understand inflation of housing costs booms in house prices, and would normally overstate inflation in depressions in house prices. In the current environement I expect to understate inflation as a large amount of housing is in foreclosure and not avaliable for renting out
 

oldreliable67

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The shortcomings in the CPI are well-known and documented. As a result, the Fed under Greenspan most often cited the Price Index for Personal Consumption Expenditures, making it by default, their preferred measure of consumer price inflation. Under Bernanke, their seems to have been a shift to the 'trimmed Mean' and 'median' CPI measures originated by the Cleveland Fed, both of which attempt to reduce exaggerations to the CPI resulting from outliers or sudden changes in supply/demand factors.

Note that the Fed is attempting to find an inflation measure that solely reflects changes in monetary policy. An ideal measure would reflect only changes in monetary policy and completely abstract from changes in supply/demand/quality changes of specific commodities/goods. The Fed can directly influence interest rates thru policy tools; it can only observe indirect effects on consumer goods (or anything else in the real economy). As of this moment, there isn't really any such measure available, so one has to make do with what one has, imperfect though it may be.
 
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washunut

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The shortcomings in the CPI are well-known and documented. As a result, the Fed under Greenspan most often cited the Price Index for Personal Consumption Expenditures, making it by default, their preferred measure of consumer price inflation. Under Bernanke, their seems to have been a shift to the 'trimmed Mean' and 'median' CPI measures originated by the Cleveland Fed, both of which attempt to reduce exaggerations to the CPI resulting from outliers or sudden changes in supply/demand factors.

Note that the Fed is attempting to find an inflation measure that solely reflects changes in monetary policy. An ideal measure would reflect only changes in monetary policy and completely abstract from changes in supply/demand/quality changes of specific commodities/goods. The Fed can directly influence interest rates thru policy tools; it can only observe indirect effects on consumer goods (or anything else in the real economy). As of this moment, there isn't really any such measure available, so one has to make do with what one has, imperfect though it may be.

As we are seeing this Fed is doing more than moving around interest rates. They have expanded the balance sheet by about $1.5 TRILLION thru QE1 and now seem on the road to incresing again. Estimates of this increase are from $500 billion to $2 trillion. Since the Fed announced the possibilty of QE2 the dollar has depreciated by about 8% and continues to fall.

It appears to be safe to say that this Fed is the most political in recent history. It also seems that they think by bringing on high inflation they will help the U.S. out of its debt problem.
 

oldreliable67

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washunut said:
It also seems that they think by bringing on high inflation they will help the U.S. out of its debt problem.

[emphasis added]

The inflation rate target most referred to by the Fed is 2%. Do you consider that 'high?' Seems to me the Fed is try to identify the 'Goldilocks' rate: not too high, not too low, but just right.' At 2%, do you think they have missed it?
 

washunut

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[emphasis added]

The inflation rate target most referred to by the Fed is 2%. Do you consider that 'high?' Seems to me the Fed is try to identify the 'Goldilocks' rate: not too high, not too low, but just right.' At 2%, do you think they have missed it?

That has been the rate discussed. You may have heard recent comments that since inflation has been low for a while having inflation higher than target may be OK. Also the Fed uses what they call core inflation. This excludes food and energy. Last time I looked that is what most people spend a lot of their money on.

Do you really believe that this Fed is more focused on trying to increase inflation to spur the economy than their mandate for keeping inflation under control?
 

oldreliable67

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washunut said:
Do you really believe that this Fed is more focused on trying to increase inflation to spur the economy than their mandate for keeping inflation under control?

Yes, I do. As of this moment, I take them at their word. I also note that there is still considerable debate within the Fed about QE2, specifically, is it the appropriate policy prescription and if so, how much? As Alan Blinder wrote in today's WSJ,

The two main thoughts that are probably going through Mr. Bernanke's head today are, first, "I sure wish I could get some help from fiscal policy," and second, "I probably can't, so I'd better do whatever I can." He's right on both counts.
 

washunut

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Yes, I do. As of this moment, I take them at their word. I also note that there is still considerable debate within the Fed about QE2, specifically, is it the appropriate policy prescription and if so, how much? As Alan Blinder wrote in today's WSJ,

No one can be certain what the correct answer is. That being said I will say that Bernanke is not an elected official. So for him to take actions that our politicians will not seems a bit scary.

Also note that the article you cite refers to just the very short term impact of the fed's actions.

I find it amazing that the country is still trying to recover from the Fed's last bout of easy money and low interest rates and we are reaching for more of the same.
 

oldreliable67

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No one can be certain what the correct answer is. That being said I will say that Bernanke is not an elected official. So for him to take actions that our politicians will not seems a bit scary.

But nonetheless, they are within the Fed's mandate.

I find it amazing that the country is still trying to recover from the Fed's last bout of easy money and low interest rates and we are reaching for more of the same.

Current conditions are quite a bit different. While low rates certainly facilitated the conditions leading to the recession, they were not the prima facie cause. They had lots of help.

We now face a different set of problems and have exhausted many of our options. Whether QE2 will be effective or not is a matter of opinion. Personally, I doubt it. I tend to agree with John Hussman, who wrote:

To assess whether QE is likely to achieve its intended objectives, it would be helpful for the Fed's governors to remember the first rule of constrained optimization - relaxing a constraint only improves an outcome if the constraint is binding. In other words, removing a barrier allows you to move forward only if that particular barrier is the one that is holding you back.
...
[On the demand side:] Does the Fed actually believe that the act of reducing interest rates from already low levels, or driving real interest rates to negative levels, will provoke consumers and businesses from acting in their best interests to improve their balance sheets?
...
On the supply side, the objective of quantitative easing is to increase the amount of lendable reserves in the banking system. Again, however, this is not a constraint that is binding. The liquidity to make new loans is already present. U.S. commercial banks already hold $1.066 trillion of reserves with the Fed, and another $1.626 trillion in Treasury and agency securities
...
In short, further attempts at QE are likely to have little effect in provoking increased economic activity or employment. This is not because QE would fail to affect interest rates and reserves. Rather, this policy will be ineffective because it will relax constraints that are not binding in the first place.

In short, nobody automatically gets a job when the Fed buys a bond. In order for QE-whatever to have a positive impact on the economy, the Fed's decision must prompt some economic actor to take some action, like spending money on hiring. Not happening so far. In other words, with QE2 (as it is presently anticipated), the Fed is simply adding to liquidity, which already exists and at a high level.

So it seems to me that, in order for QE2 to succeed, it must be combined with fiscal action. According to Ezra Klein, in 2003, Bernanke tried to advise Japan on how to escape its long stagnation. "One direct and practical approach is explicit (though temporary) cooperation between the monetary and the fiscal authorities," he said. "This direction is promising and may succeed where monetary and fiscal policies applied separately have not.'

Bernanke further advised, "Cooperation between the monetary and fiscal authorities in Japan could help solve the problems that each policymaker faces on its own." The Japanese government could stimulate the economy through tax cuts, and the central bank could print the money to pay for it. Ezra Klein summed it up this way:

The answer is obvious: "explicit (though temporary) cooperation between the monetary and fiscal authorities." In practice, that would mean Bernanke gets John Boehner, Nancy Pelosi, Harry Reid and Mitch McConnell in a room and says the politics and specifics of this are their job, but the economy needs more fiscal stimulus if it's going to recover, and the Federal Reserve stands ready to make that not only possible but also virtually costless. Inasmuch as Republicans aren't big fans of further government spending right now, the best option could be the exact one that Bernanke recommended to Japan: a Fed-financed tax cut. Perhaps a payroll-tax holiday for the next year or two.
 

oldreliable67

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No one can be certain what the correct answer is. That being said I will say that Bernanke is not an elected official. So for him to take actions that our politicians will not seems a bit scary.

But nonetheless, they are within the Fed's mandate.

I find it amazing that the country is still trying to recover from the Fed's last bout of easy money and low interest rates and we are reaching for more of the same.

Current conditions are quite a bit different. While low rates certainly facilitated the conditions leading to the recession, they were not the prima facie cause. They had lots of help.

We now face a different set of problems and have exhausted many of our options. Whether QE2 will be effective or not is a matter of opinion. Personally, I doubt it. I tend to agree with John Hussman, who wrote:

To assess whether QE is likely to achieve its intended objectives, it would be helpful for the Fed's governors to remember the first rule of constrained optimization - relaxing a constraint only improves an outcome if the constraint is binding. In other words, removing a barrier allows you to move forward only if that particular barrier is the one that is holding you back.
...
[On the demand side:] Does the Fed actually believe that the act of reducing interest rates from already low levels, or driving real interest rates to negative levels, will provoke consumers and businesses from acting in their best interests to improve their balance sheets?
...
On the supply side, the objective of quantitative easing is to increase the amount of lendable reserves in the banking system. Again, however, this is not a constraint that is binding. The liquidity to make new loans is already present. U.S. commercial banks already hold $1.066 trillion of reserves with the Fed, and another $1.626 trillion in Treasury and agency securities
...
In short, further attempts at QE are likely to have little effect in provoking increased economic activity or employment. This is not because QE would fail to affect interest rates and reserves. Rather, this policy will be ineffective because it will relax constraints that are not binding in the first place.

In short, nobody automatically gets a job when the Fed buys a bond. In order for QE-whatever to have a positive impact on the economy, the Fed's decision must prompt some economic actor to take some action, like spending money on hiring. Not happening so far. In other words, with QE2 (as it is presently anticipated), the Fed is simply adding to liquidity, which already exists and at a high level.

So it seems to me that, in order for QE2 to succeed, it must be combined with fiscal action. According to Ezra Klein, in 2003, Bernanke tried to advise Japan on how to escape its long stagnation. "One direct and practical approach is explicit (though temporary) cooperation between the monetary and the fiscal authorities," he said. "This direction is promising and may succeed where monetary and fiscal policies applied separately have not.'

Bernanke further advised, "Cooperation between the monetary and fiscal authorities in Japan could help solve the problems that each policymaker faces on its own." The Japanese government could stimulate the economy through tax cuts, and the central bank could print the money to pay for it. Ezra Klein summed it up this way:

The answer is obvious: "explicit (though temporary) cooperation between the monetary and fiscal authorities." In practice, that would mean Bernanke gets John Boehner, Nancy Pelosi, Harry Reid and Mitch McConnell in a room and says the politics and specifics of this are their job, but the economy needs more fiscal stimulus if it's going to recover, and the Federal Reserve stands ready to make that not only possible but also virtually costless. Inasmuch as Republicans aren't big fans of further government spending right now, the best option could be the exact one that Bernanke recommended to Japan: a Fed-financed tax cut. Perhaps a payroll-tax holiday for the next year or two.
 

washunut

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But nonetheless, they are within the Fed's mandate.



Current conditions are quite a bit different. While low rates certainly facilitated the conditions leading to the recession, they were not the prima facie cause. They had lots of help.

We now face a different set of problems and have exhausted many of our options. Whether QE2 will be effective or not is a matter of opinion. Personally, I doubt it. I tend to agree with John Hussman, who wrote:



In short, nobody automatically gets a job when the Fed buys a bond. In order for QE-whatever to have a positive impact on the economy, the Fed's decision must prompt some economic actor to take some action, like spending money on hiring. Not happening so far. In other words, with QE2 (as it is presently anticipated), the Fed is simply adding to liquidity, which already exists and at a high level.

So it seems to me that, in order for QE2 to succeed, it must be combined with fiscal action. According to Ezra Klein, in 2003, Bernanke tried to advise Japan on how to escape its long stagnation. "One direct and practical approach is explicit (though temporary) cooperation between the monetary and the fiscal authorities," he said. "This direction is promising and may succeed where monetary and fiscal policies applied separately have not.'

Bernanke further advised, "Cooperation between the monetary and fiscal authorities in Japan could help solve the problems that each policymaker faces on its own." The Japanese government could stimulate the economy through tax cuts, and the central bank could print the money to pay for it. Ezra Klein summed it up this way:

what you are saying is all plausible. That being said I would note that the Federal government is currently running a deficit in the neighborhood of $1.3 trillion. Until two years ago that you have been considered wildly stimulative. We may want to consider if the problems faced today are more structural in nature and therefore short term solutions may not be the fix. These attempts at a short term fox for a long term problem may in fact just be digging the hole we have to climb out of deeper.

It could be that this problem has more to do with living in a world economy that will not allow Americans to live at a materially higher standard of living than their peers in other parts of the world. It is interesting that we talk about the gap of rich and poor but myopically speak of it in terms of Americans only. Looking at the rest of the world, perhaps they are saying why should a factory worker in the U.S. have two cars, three TVs, cable TV, etc when our workers live without almost any of those things. In a world where American workers compete with several billion aspiring workers in emerging markets we are still grossly overpaid.

More and more America reminds me of post war England. A nation that still thinks of itself THE world power when it is no longer the case.
 

phattonez

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It could be that this problem has more to do with living in a world economy that will not allow Americans to live at a materially higher standard of living than their peers in other parts of the world.

Oh yes it will. Americans are typically much more productive than anyone else in the world. We just have great skills and great capital accumulation. Some areas are overpaid, but generally we are much better off than the rest of the world beacuse we are much more skilled than the rest of the world.

It is interesting that we talk about the gap of rich and poor but myopically speak of it in terms of Americans only. Looking at the rest of the world, perhaps they are saying why should a factory worker in the U.S. have two cars, three TVs, cable TV, etc when our workers live without almost any of those things. In a world where American workers compete with several billion aspiring workers in emerging markets we are still grossly overpaid.

GM was failing for a reason. :)
 

washunut

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Oh yes it will. Americans are typically much more productive than anyone else in the world. We just have great skills and great capital accumulation. Some areas are overpaid, but generally we are much better off than the rest of the world beacuse we are much more skilled than the rest of the world.



GM was failing for a reason. :)

I would like to agree with you. But I am talking about factory workers here versus abroad. Please remember than capital is fungible. Companies will build factories where they can get the biggest returns. So if you were going to build a factory that could produce 100 widgets per hour and it would take one person to man the machine. Would you build the machine in the U.S. and pay that worker $30 per hour or in Asia and pay $2 per hour. There are certainly other costs such as shipping, time to market etc that have to be factored in. But there is a reason why millions of jobs have offshored. Our economy has been able to drift along largely through financial engineering, but even that industry will soon be offshored.
 

phattonez

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I would like to agree with you. But I am talking about factory workers here versus abroad. Please remember than capital is fungible. Companies will build factories where they can get the biggest returns. So if you were going to build a factory that could produce 100 widgets per hour and it would take one person to man the machine. Would you build the machine in the U.S. and pay that worker $30 per hour or in Asia and pay $2 per hour. There are certainly other costs such as shipping, time to market etc that have to be factored in. But there is a reason why millions of jobs have offshored. Our economy has been able to drift along largely through financial engineering, but even that industry will soon be offshored.

But who cares if we lose one specific sector? We make more money running those factories overseas than we would by having them here. We should bemoan the loss of factory jobs just as we should bemoan the loss of horse and buggy operators. It allows us to advance to do something better.
 

Missed AB

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But who cares if we lose one specific sector? We make more money running those factories overseas than we would by having them here. We should bemoan the loss of factory jobs just as we should bemoan the loss of horse and buggy operators. It allows us to advance to do something better.

I think most people don't realize that the US is is no longer an industrial super-power. We have made the move to become a technological and information super-power.
 

phattonez

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I think most people don't realize that the US is is no longer an industrial super-power. We have made the move to become a technological and information super-power.

Yes, we are an industrial super power.

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