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« Worries about Inflation: A Chat with Mark | Main | Musings 6-18-07 »

June 18, 2007


Bill aka NO DooDahs!

Regardless of our opinions about the various price indices, the fact remains that they are data series that stretch back many years. The data, whether flawed or not, is at least relatively consistent in construction. This provides a huge number of test-able observations from which one could build a model to interpret how traders and investors react to changes in the series. The failure of some writers, who supposedly have a reputation for economic knowledge, to integrate this huge volume of data into a cohesive and accurate prediction of stock market movement, is quite amusing to me.

Even more amusing to me is the insistence of these same writers that the data is flawed, while ignoring the fact that their methods of integrating that data are at fault.


One quick question: Just beause the Fed knows that they can't directly control oil prices which tend to introduce noise into inflation indicators, does that mean they are just going to sit on there hands and let inflation possibly increase beyond their liking?

I don't think so. Remember in '06 when the economists' consensus was for the Fed to stop hiking rates in May, but they deferred until August causing the summer crash? They stayed extra hawkish just to make sure they had squashed inflationary pressures regardless of their lack of control over energy prices.

Just a thought.


Chris -

Actually, they prefer the core PCE deflator, which has different weightings from those used in the CPI. Their statements about the comfort zone and targets are all based upon changes in that measure. My main point is that those who want to understand what is happening for investment purposes should take them at their word. Fed communications have been pretty open on such matters.

In a sense, their reason does not matter. What I say about this is "educated speculation" from reading books about the Fed, the words of former governors, and studying political institutions for a long time.

Every institution has "norms" and new members learn those norms quickly. Fed Governors all talk tough about fighting inflation expectations -- even the "doves". They work hard to reach a consensus before actual votes.

Core measures have been used for over thirty years. The original introduction reflected the inability to cut OPEC prices by raising interest rates, although some cite the desire to help the Nixon re-election campaign. In recent years the "volatility explanation" has been popular.

So -- the Fed is not going to come out and say that this is the reason, but you can bet they are well aware of the reach and limitations of their policy actions.

A good question, and I wish I could give a more definitive answer.




Barry --

Yes, we have a few hundred very smart people who work on this all of the time. The are either clueless bozos who never buy gasoline, or they are looking at something different from the average consumer.

You had an intriguing post a while back that talked about the generally increasing quality of life. The idea was that it was something we were all entitled to. I'm probably stating it incorrectly, but that is how I remember it.

The BLS tries to measure these quality changes, and they have an impact, especially in things like technology and health insurance. I think that is part of the difference in the Fed view.

But the main point is that they have the power. You and I do not. Let's accept reality as part of our forecasts.

Thanks for your comment,



So, do you think that the Fed prefers the core CPI as a measure of inflation because it captures the aspects of inflation that the Fed can influence? In other words, since Fed policy has little influence over food and energy prices, do they worry more about prices that they have some control over?

Am I understanding this correctly?

Barry Ritholtz

"The Fed actually believes that CPI overstates inflation. We know that seems incredible to those who read the barrage of commentary, but it is true."

What more can anyone say beyond that?

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