Inflationeering

As BusinessWeek asked way back in 2005 before the bubble burst:

Wondering why inflation figures are so tame when real estate prices are soaring? There is a simple explanation: the Consumer Price Index factors in rising rents, not rising home prices.

Are we really getting a true reading on inflation when home price appreciation isn’t added into the mix? I think not.

I find the idea that house price appreciation and depreciation is not factored into inflation figures stunning. For most people it’s their single biggest lifetime expenditure, and for many today mortgage payments are their single biggest monthly expenditure. And rental prices (which are substituted for house prices) are a bad proxy. While house prices have fallen far from their mid-00s peak, rents have continued to increase:

Statisticians in Britain are looking to plug the hole. From the BBC:

A new measure of inflation is being proposed by the Office for National Statistics (ONS).

It wants to create a version of the Consumer Prices Index that includes housing costs, to be called CPIH.

The ONS wants to counteract criticisms that the main weakness of the CPI is that it does not reflect many costs of being a house owner, which make up 10% of people’s average spending.

While a welcome development (and probably even more welcome on the other side of the Atlantic) it doesn’t make up for the fact that the explosive price increases during the boom years were never included. And it isn’t just real estate — equities was another market that massively inflated without being counted in official inflation statistics. It would have been simple at the time to calculate the effective inflation rate with these components included. A wiser economist than Greenspan might have at least paid attention to such information and tightened monetary policy to prevent the incipient bubbles from overheating.

Of course, with inflation statistics calculated in the way they are (price changes to an overall basket of retail goods) there will always be a fight over what to include and what not to include.

A better approach is to include everything. Murray Rothbard defined inflation simply as any increase to the money supply; if the money is printed, it is inflation. This is a very interesting idea, because it can reflect things like bubble reinflation that are often obscured in official data. The Fed has tripled the monetary base since 2008, but this increase in the monetary base has been offset against the various effects of the 2008 crash, which triggered huge price falls in housing and equities which were only stanched when the money printing started.

Critics of the Austrian approach might say that it does not take into account how money is used, but simply how much money there is. An alternative approach which takes into account all economic activity is nominal GDP targeting, whereby monetary policy either tightens or loosens to achieve a nominal GDP target. If the nominal target is 1%, and GDP is growing at 7%, monetary policy will tighten toward 1% nominal growth. If GDP is growing at a negative rate (say -2%), then the Fed will print and buy assets ’til nominal GDP is growing at 1%. While most of the proponents of this approach today tend to be disgruntled Keynesians like Charles Evans who advocate a consistent growth rate of around 5% (which right now would of course necessitate the Fed to print big and buy a lot of assets, probably starting with equities and REITs), a lower nominal GDP target — of say, 1% or 2% — would certainly be a better approach to the Fed’s supposed price stability mandate than the frankly absurd and disturbing status quo of using CPI, which will always be bent and distorted by what is included or not included. And for the last 40 years monetary policy would have been much, much tighter even if the Fed had been pursuing the widely-cited 5% nominal GDP target.

I don’t think CPI can be fixed. It is just too easy to mismeasure inflation that way. Do statisticians really have the expertise to determine which inflations to count and which to ignore? No; I don’t think they do. Statisticians will try, and by including things like house prices it is certainly an improvement. But if we want to be realistic, we must use a measure that reflects the entire economy.

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50 thoughts on “Inflationeering

  1. Pingback: Inflationeering « Financial Survival Network

  2. if you remember, Greenspan also said on AT LEAST one occasion that they were specifically EXCLUDING executive compensation from consideration in the inflation statistics. this drew a little bit of comment at the time because it was back when Bill Gates was the richest man on the planet … and the compensation and option plans of many other CEOs were starting to draw attention.

    kinda funny. devalue the currency overall but hide the inflation primarily in Stuff Rich People Buy so the hoi polloi don’t notice what’s going on. until everything blows up, of course.

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  4. Give a bunch of guys the ability to create money out of thin air, and guess what’s going to happen?

    Inflation is theft, at best. Imagine another institution coming out and saying [as does the Fed with its "2% inflation target"], “we are going to steal 2% from you and [nearly] everybody else once again this year.”

    Most of the the fraud and theft that takes place in this country is perfectly legal, as is the above example. Get rid of 99% of the laws, and freedom will, slowly but surely, find its way back to America.

    • Fiat money has been around a long time. I think anyone who wants to learn the rules of the game can and should. I think there is a systemic reset coming, but I strongly believe there will be fiat currencies afterwards. The poor love it because the government can give them bread and circuses. The rich love it because banks get the ability to print money and give it to their friends.

      • Perhaps, but it seems unlikely, at least initially. The system will need to restore confidence in the banking system and that means a return to real money, until, of course, people forget, and then it time for fun and games once again!

        Counterfeiting is one of the oldest cons on the planet.

        • The people with the most gold all want us to believe that gold is not money, and that gold is a barbarous relic so we will happily live off their fiat intermediaries while they retain te hard stuff. It is, I think, inevitable that they will win the propaganda war.

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  8. The U.S. government CPI calculation was changed to omit food and energy in order to mask true consumer inflation. While it depends on what you buy, business/investment economists contend that true inflation is as much as 6-8% per year instead of the official appx. 2%. For the same purpose, to fool the people, the government deliberately understates unemployment far more.

    • Who knows what anything [statistically] is anymore? Just the same, reality suggests that when the quality of most products and services are heading south, all kinds of manipulations are taking place.

      Money is the common denominator for nearly all vice and all mis-behavior. And the more obscure money becomes vis a vis its representation as labor-value, the uglier it gets.

    • There are lots of different CPIs. The headline still includes food and energy, but not mortgage costs. The one you’re talking about is core CPI, which omits food and energy which is absolutely bizarre. Supposedly the reason is that food and energy costs are volatile, and are a bad reflection of the impact of monetary policy. I think that that is totally ridiculous, and even more stupid than the idea of omitting mortgage costs, though it is interesting to see the data.

  9. Trying to rectify a flawed statistic (CPI) by targeting a nominal value in another flawed statistic (GDP) doesn’t seem like it would improve things much.

    “Improving” GDP by having the government spend more on non-productive uses is just another Keynesian pipe-dream.

    • It is not my ideal, not at all, but if we have to have a fiat system it seems vastly better to have one that would have been much, much tighter the last 40 years, leading to less destructive bubbles.

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  11. It is all a rigged game. They misquote statistics to get a simple headline number the media can quote. This keeps the average media reader under the notion (spell) that inflation is only 3%, so their pension/wage increase of 3% is fair.

    For years my father said the cost of living was going backwards. When I think what his wage was in the early 90’s and what it is today, and what he can buy now compared to then, I can see that the MEDIAN REAL wage in Australia has gone backwards. I assume this is the case for most Western countries. They always quote and AVERAGE wage figure. No wonder society gets left behind. The top 1%, especially Government workers and Union heavyweights get wage rises higher than inflation. And don’t get me started with Executive pay.

    When Editors of papers won’t run with information that counters the common notion, you know they have the interests of vested interests at heart.

    My mother works for a broadsheet paper which is in terminal decline. Perhaps peope will start using non MSM as their news news and will start to ask more questions that the politicians can cover up. It will require a vigilant population and people willing to run as candidates (Ron Paul types). But who is going to back these grass roots politicians? It takes a lot of time and money to get elected.

    I had an interesting insight after talking with a wealthy uncle. He is a glass half full type, and was quoting the propaganda of the media (I knew it was incorrect) He was accepting the lies as facts and this gave him a positive attitude to make investment decisions. Then I realised why he was rich. He was the type of person that acts according to the governments wishes. It is people like him that the government needs to start spending, take on loans to invest etc. When the Government prints money (Buys toxic mortgages), and the banks have the ability to lend to people like him, they can achieve the desired results (Kickstart the economy). People like me and many other readers do see to many negatives in the economy and this influences our conservative and cynical attitude.

      • For 10 years I said property was overvalued, and he go richer. Now property is declining but he seems to be still getting ahead in mining town RE. The point being he is an opportunist, and when banks lend into hot areas, the early adopters take the cream.

    • The price of honesty and integrity has almost always been [relative] poverty. I know many, many wealthy people who are more than willing to “play the game” any way it must be played to, “act in the interests of themselves and their families.”

      There seems to be no end to the creativity of the rationalizations people use for stealing money from other people.

  12. absurd or not, here’s an article from 2000 discussing exactly this stance of the Federal Reserve:
    http://www.commondreams.org/views/042000-104.htm
    “… the Federal Reserve has refused to examine the potential inflationary effect of billion-dollar New Economy stock compensation packages for CEOs …”

    i doubt very much that Bernanke is any better.

    but then, i consider the GDP formula to be an economic endorsement of perpetual motion and a powerful example that current economic theory stands in direct opposition to reality.

  13. My understanding is that inflation is an increase in the monetary supply disproportionate to the actual production of the society, where money should simply be a representation of said production.

    And that inflation is a tax on the poor because instead of distributing the counterfeit money equally to all (in proportion to what they previously had), the excess money goes to those with initial access to the essentially counterfeit (as opposed to true wealth that must be marked to something produced) money i.e. BANKERS. It trickles down from there, but by the time it reaches the bottom they have less than they should.

    • Bingo! Who were the borrowers who were given access to cheap plentiful credit at the beginning of the 90’s?

      The same ones who rode the market up and probaby cashed out in 2006, then bought back in 2009.

      Theft by association.

  14. NGDP targeting sounds like managerialism of the worst kind to me (then again, I am weird). It would forever prevent therapeutic creative destruction episodes like that seen in the 1920-1921 depression and many times before that – that was the last one before the Feds took over (as per Bill Bonner and James Grant). Also similar to what the Baltic countries have done: http://www.president.ee/en/media/bibliography/selection-of-media-articles/7611-qwhy-toomas-ilves-is-right-and-paul-krugman-wrongq-postimees-12-june-2012/index.html

    Maybe those episodes could occur even with that targeting, but God knows how they would look? Maybe they would always end up with the destruction of the currency (probably together with a more pronounced destruction of the economy than would have been warranted).

    • I would add that even intuitively, for a non-interventionist, the mandate of (a certain degree of) price stability (possibly with the added goal of bursting what we learned are dangerous bubbles – from hundreds of economic history) seems much more reasonable than mandating a fixed rate of growth, come hell or high water. Intuitively (my intuition I mean), NGDP targeting would bring about the destruction of the USD and would be a goldbug’s wet dream (at least in the months of chaos before they institute some SDRs or something).

    • Well my defence of NGDP targeting is that it’s better than the status quo, not that I particularly like it. First of all, Sumner adopted it from Hayek. It is, more or less an Austrian idea. Having contractionary depressions where the money supply falls (the status quo) doesn’t really seem to be very healthy. It seems to me like the kind of episode that takes down good businesses with the bad. Under NGDP targeting, I like to imagine that there can still be liquidations of bad businesses and structures, perhaps even moreso than the status quo, where the contraction of the money supply leads central planners into bailing out ALL failing businesses (thus saving the bad as well as the good). With NGDP targeting, the arbitrary growth in the money supply could (I hypothesise) allow the good businesses to survive while bad businesses fail. Of course, it could be rigged up as a crony system to produce bad outcomes, but would they be worse than the status quo? I doubt it.

      I would add that if I was to endorse any form of NGDP targeting, I would endorse a much lower growth target than virtually everyone else who advocates such a thing, probably 2% at tops, rather than the hugely inflationary 5% Sumner (etc) advocates.

        • Andrei the idea NGDP targeting would immediately destroy the dollar is totally false, unless the NGDP target was like 100%. Even if the target was 5%, as soon as the target hits the central bank will tighten. The kind of boom we have to be afraid of is when NGDP growth goes to 10% and the central bank thinks this is good and doesn’t (massively) tighten, which is much more likely under a traditional Keynesian money printing regime.

        • I’m wary of claims including “totally” especially in economics where it seems that almost anything goes. And by the way, wasn’t the dollar going to die soon enough anyway according to yourself? Or is this the way to save it? If so, I fail to see that. Then again, I must stress that only the really big countries can play theoretical games like this – for the smaller players, the laws of economics (I mean those commonsensical ones) will force a resolution soon enough. And to address your point, I actually do believe there’s a high probability that (death of USD) will actually happen in that case – I can’t say more due to lack of time and anyway I’m living in a world of a thousand variables and to dismantle my intuitions would be a tortuous process.

        • I’m wary of claims including “totally” especially in economics where it seems that almost anything goes. And by the way, wasn’t the dollar going to die soon enough anyway according to yourself? Or is this the way to save it? If so, I fail to see that.

          Well, yeah, as I’ve written about many, many times the dollar system is undergoing a huge change, and that is already cast in stone because the machinations of the global economic system are already in motion.

          I think adopting a 2% NGDP target right now would probably prolong things a little, to be honest, because I think the death of the dollar is not really a problem of inflation at all, it’s a problem of international affairs. I partly buy the idea that the United States has a demand-side problem — obviously raising aggregate demand won’t really deal with the deeper underlying socio-economic problems (deindustrialisation, energy dependency, the degeneration of the dollar system, etc etc etc), it will only kick the can a little — but all the doomsayers who like 2009 and 2010 are saying “IF THEY PRINT ALL THIS MONEY THE DOLLAR IS GOING TO ZERO TOMORROW AND WE WILL BE THE NEXT GREECE” are completely wrong, just as they were in 2009 and 2010 when the Fed tripled the monetary base.

          So this isn’t a way to save it so much as something that could have greatly prolonged it had it been adopted by the monetary regime in 1971. The bubbles need not have been puffed up in the first place, and the much tighter monetary policy that NGDP targeting recommends (even with a 5% target) would have resulted in a lot of tightening relative to what actually happened.

      • It seems to me like the kind of episode that takes down good businesses with the bad.

        Oh! The road to hell is paved with good intentions. This is how the Feds first rationalized their first moves post 1921. We’re either non-interventionist, OR we start down the path that leads to where we are now. The good businesses should be bailed out by those that have cash on the sidelines (if they’re so good, and market is at least somewhat efficient), and if not, it won’t be long before those smart men and engineers that have been fired will start businesses or will be hired again.

        • Andrei I’m not advocating any kind of bailouts other than those the market does itself, and if anything this system is much less likely to produce bailouts because the arbitrary (and CRUCIALLY limited, i.e. if it exceeds that amount the Fed tightens) NGDP growth counteracts debt-deflationary episodes. I foresee that it would result in the least interventionist kind of monetary policy, much, much less so than what we have seen in the past 40 years. Look at Soltas’ graph of what NGDP targeting would have done with a 5% target since WW2. Even a 5% target is MUCH more hawkish (and thus much less bubble and bailout-inducing) than the status quo.

          http://esoltas.blogspot.co.uk/2012/06/feds-chickenhawks.html

          With my 2% target, we’d see an even more hawkish regime.

        • OK, then I guess we can end our conversation on this topic here as neither of us seems convinced by the other’s arguments. As for that graph (didn’t even click the link, I have to go), I’m wondering how many gazillion assumptions have been required to show what NGDP would have supposedly done in 50 years.

        • Seriously, click the graph, you need to see it. For most of the time when a 5% NGDP target would have meant tightening the Fed was still running a very loose monetary policy. It’s the most damning graph I’ve seen regarding the Fed’s loose and easy bubble-creating policy in the last 40 years.

  15. If you have a network of Cray computers, and a big team of analysts, statisticians, and census collectors, and PROVIDED the survey respondents provide ACCURATE responses, then the Central Bank planners, and Bureaucrat heads will make a correct decision which will guide the economy in the direction and inflation level required.

    If they can’t use more powerful computers and resources!

    When I was a high school economics student, I thought wow the Government and Central bank are so smart. Can you imagine what the general public thinks of these GODS.

    When the general public realises the damage these Gods have done to their lives, they will demand austerity in the public sector, abolition of the monopolist industries through a repeal of suffocating legislation, and lower taxes. Labour laws will be liberalised to encourage the long term unemployed to be employed. With increased productivity inflation will be abolished. Deflation in goods and real increases in income to the middle and lower classes will right the inequities we face today.

    Sack politicians and sack government workers. Lower taxes for people who have the guts to innovate and improve our lives.

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  22. 1) Props for citing Rothbard. He was a scholar par excellence.

    2) If we had negative growth of say, -5%, and the Fed had to push up inflation to even a modest 1%, the annual devaluation would be rather high. It’s pushing on a string; what if they lower rates to zero, but inflation cannot pick up because banks are holding onto the money?

    What if the BEA claims that nominal GDP is 1% and its really 0%? Then they’ll have to print even more. The question is which indicator they will manipulate.

    Also, who is to say that 1% growth is the natural rate? If the markets determined the cost of money, the real growth rate could be 10% for all we know!

    I’d be more open to an interpretation of Friedman’s K-percent rule where the money supply expands at a constant rate (relative to population growth). That way, the Fed does not meddle with the business cycle. The Fed is only necessary for rescuing those in a liquidity crunch because of overlevering, systemic risk, and fractional reserves.

    Commodity-money is too fixed and results in imbalances of power and periodic deflationary episodes. Fiat money is subject to manipulation, error, and is a means to control and quietly tax the populous. There is a middle way, of course; decentralized credit. Credit should expand or contract as money becomes necessary (to reflect the total goods and services in the economy). The money of the future will be created through community credit unions. This has happened in many periods of uncertainty on a local level.

    An example is the Swiss WIR Bank.
    http://www.reinventingmoney.com/documents/wir.html

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