12 May 2011

$70 Fill Ups and Low Inflation Rates

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Joe Queenan does a fine job of mocking the federal government’s “core inflation rate” calculation methodology.

[I]magine my surprise when the latest economic data came out and we were told that inflation wasn’t much of a problem at all. The price index for core personal consumption expenditures increased a piddling 0.9% from the previous year, keeping the national inflation rate far, far below what economists see as the danger level.

Hang on a second, I thought: What about my exorbitant fuel costs and the two bucks for my disgusting coffee and the $1.25 for my stale, tasteless bagel, with no schmear, no butter, no nothing? If inflation had jumped just a puny 0.9% in the past 12 months, why did it feel like everything that I bought last week had gone up 25%?

The answer lies in the way economists calculate what they call “core” price indexes. The core personal consumption expenditures index (PCE), for example, computes the cost of a representative basket of goods that consumers might buy—like used copies of “Madden 2009” and lace camisoles and jumbo-size containers of Percocet and personally autographed Kenny Chesney guitar picks and Blu-ray discs of “AVP: Alien vs. Predator” —but it cuts out variables like food and energy prices. This makes the month-to-month reporting on inflation less volatile, far less subject to the vicissitudes of the market.

At first glance, this seems baffling. Removing fuel and food costs from the index purely for the sake of statistical balance seems a bit like saying, “All told, four million people died in World War II. Well, unless you include the people who died in concentration camps. And, oh yeah, the 20 million Russians.” It’s a bit like saying, “On average, a major league baseball team will win 3.2 World Series each century. Obviously, not the Cubs. And we’ve thrown out the New York Yankees and their 27 world championships because it doesn’t provide a true snapshot of the game at any given moment.” It’s a bit like saying, “Billy Joel never wrote a single song that just totally sucks and makes people’s skin crawl. Unless you include ‘Captain Jack.’ Which we deliberately left out of our sample because it skews the results. Maybe we should have left out ‘Piano Man,’ too.”

Read the whole thing.

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One Feedback on "$70 Fill Ups and Low Inflation Rates"

SDD

Core Inflation measures what it measures. The fact that it doesn’t measure something else that you think is more important is irrelevant. The most frequently reported player statistic in baseball is batting average. There are other statistics that many argue are a better picture of “player performance”, but batting average still measures what it measures — the past probability of getting a hit at an at-bat.

Focus on CPI (of any kind) disguises the really salient point — which is monetary inflation. When you create more money, you devalue each unit of currency. This ultimately affects general price levels, but in the short run, CPI is also affected by things like money velocity (still low right now). In the long run, creating more money WILL result in higher general prices unless you can keep the velocity of money low permanently (never been done). More likely what happens is that some future Fed will have to drastically reduce the supply of money, which will certainly trigger another recession (see Paul Volcker and the early 1980s). Mr. Bernanke and the President are counting on this happening AFTER 2012.



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