The Shape of 40 Years of Inflation

I have written before that there is no single rate of inflation, and that different individuals experience their own rate dependent on their own individual spending preferences. This — among other reasons — is why I find the notion of single uniform rate of inflation — as central banks attempt to influence via their price stability mandates — problematic.

While many claim that inflation is at historic lows, those who spend a large share of their income on necessities might disagree. Inflation for those who spend a large proportion of their income on things like medical services, food, transport, clothing and energy never really went away. And that was also true during the mid 2000s — while headline inflation levels remained low, these numbers masked significant increases in necessities; certainly never to the extent of the 1970s, but not as slight as the CPI rate — pushed downward by deflation in things like consumer electronics imports from Asia — suggested.

This biflationary (or polyflationary?) reality is totally ignored by a single CPI figure. To get a true comprehension of the shape of prices, we must look at a much broader set of data:

Yet the low level of headline inflation has given central banks carte blanche to engage in quantitative easing, and various ultra-loose monetary policies like zero-interest rates — programs that tend to benefit the rich far more than anyone else. Certainly, lots of goods and services — especially things like foreign-made consumer goods and repossessed real estate — are deflating in price. But you can’t eat an iPad or a $1 burnt-out house in Detroit. Any serious discussion of monetary policy must not only consider the effects on creditors and debtors, but also the effects on those who spend a larger-than-average proportion of their income on necessities.

Another issue is that CPI leaves out both house prices as well as equity prices.

Below is CPI contrasted against equities and housing:

It is clear from this record that a central bank focused upon a price index that fails to include important factors like stock prices and house prices can easily let a housing or stocks bubble get out of hand. CPI can — as happened in both the 1990s as well as the early 2000s — remain low, while huge gains are accrued in housing and stocks. Meanwhile, central bankers can use low CPI rates as an excuse to keep interest rates low — keeping the easy money flowing into stocks and housing, and accruing even larger gains. However, because such markets are driven by leverage instead of underlying productivity, eventually the ability to accrue new debt is wiped out by debt costs,  hope turns to panic, and the bubble bursts.

Both of the above examples indicate that the contemporary headline price index measures of inflation are deeply inadequate. Attempts to measure the rate of inflation that ignore data like house or stock prices will lead to flawed conclusions (rendering any such notions of “price stability” as meaningless), which has tended to lead to failed policy decisions such as those which led to the bust of 2008.

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41 thoughts on “The Shape of 40 Years of Inflation

  1. Brilliant work and this should have been done 10 years ago. I have argued this before. The low CPI numbers are an excuse to keep real pensions down, and to inflate the housing bubble. If they used real inflation numbers they would have had to raise rates to keep inflation in their 2-3% range.

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  3. First of all, those are some sweet charts you’ve got! Did you build that?

    I know you’re not a classically educated economist (that’s what makes you so cool), but you should probably familiarize yourself with some of the other crazy shit we do with inflation:

    http://seekingalpha.com/article/24933-substitutions-and-hedonics-inflation-data-absurdities
    and
    http://www.peakprosperity.com/crashcourse/chapter-10-inflation

    The point that the whole world seems to miss is that inflation and “price stability” are two different animals…..

    I gotta go, talk to you later.

    • Yeah, I prefer to make my own charts. But not with government data, so I suppose by Obama’s standards I didn’t build that.

      The methods Ritholtz is talking about is something I am actually showing here, although I don’t really go into details about hedonics and substitutions, but in showing inflation by sector you do get less manipulation.

      As for the whole Austrian argument about whether inflation is price changes or just inflation on the money supply, well that’s totally definitional. I think the Austrian view is a good heuristic, but I don’t think it’s absolutely true under all circumstances.

      • Gotcha on part one, but tha’s not what I was talking about on part 2.

        I’m talking about the twisted definition the fed uses for “price stability.” Price stability means if a dozen eggs was $2 yesterday, it should be $2 today, and $2 tommorow. If it was $1 yesterday $3 todayand will be $2 tomorrow that’s not price stability. Look at the commodity markets:

        http://finviz.com/futures_performance.ashx

        Yesterday 10 commodities moved more than 1%. How’s that price stability?

        Of course the main reason for commodity price insability is currency instability:
        http://finviz.com/futures_charts.ashx?t=CURRENCIES

        The Fed completely ignores its mandate for price stability, deliberately misinterpreting it as inflation targeting. Of course actually targeting true price stability would mean closing the casino, not defending it.

        • Price discovery for me is far more important than price stability. Being able to ensure the kind of price stability you’re talking about would require a very high degree of central planning, something that would cause many other problems. I personally believe prices should vary relative to demand and relative to supply, so I don’t think “price stability” is a good mandate at all, and smacks of central planning.

  4. Great work but the Fed looks at PCE deflator, not CPI, to decide monetary policy. A common critique of the CPI is just a straw man argument (most Austrians are guilty of this). The correct comparison is against PCE deflator. Nevertheless both include clothing, transportation, shelter, and medical care. The prices of food and energy are mostly driven by exogenous supply and demand, and as a result they increase the volatility of the inflation measurement. This is precisely the whole reason the Fed excludes them. Furthermore. the argument of “higher-than-actual” inflation we always hear from Austrians conveniently fails to include prices for technologies such as smartphones or TVs that have been in fast decline. How much is a blu-ray player today versus 2 years ago? Or an iPhone? We’re also not experiencing any wage inflation either. How many years of low inflation / near-deflation must we experience before the Austrians grasp reality?

    • PCE; CPI, same methodology. Neither account for the bubbly price increases we saw in stocks and housing. Greenspan Fed should have tightened. A nominal GDP target of 5% (tighten over, loosen under) would have ensured a much, much tighter monetary policy, for example.

      As for the “higher than actual” inflation argument; no — as a whole the official figures are roughly correct, the BPP has confirmed this. The issue is not that inflation is higher than the BPP but that it hits different groups of people differently. There is a lot of deflation in debt-oriented assets (e.g. residential real estate) and consumer goods. But that makes no difference if you’re a pensioner without a mortgage living on a fixed income spending a disproportionately high level of your income on food and energy.

      My point is more that there is no uniform rate of inflation and that the Fed needs to look for another definition of price stability.

  5. Can anybody actually name anything that is not driven by supply and demand, however “not real or true” or authentically representative those 2 elements may be in any given situation during a particular point in time? I expect that idea to land in the same sphere of ‘all things being equal’ modes of thought. And can someone please explain what this apparently wildly popular word “exogenous” is supposed to mean? Steve Keen is an authority on this, I think..

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  7. What led to the 2008 bust were Wall Street bankers who repackaged toxic assets with over-rated investments and sold them to foreigners, then tried to pay for the investment returns by borrowing even more. Meanwhile, several of the clients insured their loans while others used the investments to borrow more, etc. That’s why the result was over a quadrillion dollars (notional value) in unregulated derivatives.

    • Many, many things led to 2008. I do not think the Austrian school is incorrect in pointing to the flow of easy credit — it is far easier to create toxic junk with a steady stream of easy credit.

  8. Aziz,

    Don’t get sucked in by the egg example. Oil has traded everywhere from $147 to $33 in the last four years. Stable Price? Supply and Demand? Price discovery? or casino capitalism?

    Are you trying to justify the three ring circus that is the currency market? You simply can’t have price stability OR price discovery without stable currencies, and that means sound money.

    Like it or not, the Fed has a very simple, two-word mandate “Price stability.” Not “Price discovery”, not “targeted 2% inflation.” Instructions don’t get any easier. If you want to argue about changing the mandate, that’s one thing, but when you misinterpret simple words(because you think you know better) , you just become another meddling clown.

    • My point is that the Fed’s mandate is impossible, Mark.

      So long as people are free to set their own prices there will be price instability. While I think we are both aware of the long-term purchasing power erosion of fiat, there are many historical examples of hard-money regimes which have been deeply instable too.

      I don’t want anyone centrally planning the money supply, whether that is a discretionary or nondiscretionary regime. I want competition in money so that individuals engaging in commerce can itself choose whichever means of payment — commodity-backed paper, precious metals, government fiat, foreign government fiat, private fiat, cryptographic currencies — best suits their purpose. The money supply, the nature of money, the value of money and the origin of money should be determined by market demand.

      • Fair enough. My point is the Fed has made no attempted to follow its mandate. These casino games are not price discovery mechanisms. There’s no reason for currencies to be revalued against one another every nanosecond, 24hrs a day, five days a week. Or letting banks using infinite leverage and ficticious supply determine the price of corn so they can win FRNs.

        We’ve become addicted to “price action” which has nothing to do with price discovery.

        Price stability doesn’t preclude prices changing. It should preclude wild, irratic short term movements. The Fed willfully ignored the housing bubble (casue hey, all those people agreed to those prices; supply and demand, right?…Not really).

        I still see nothing wrong with the mandate itself, and the “solutions, ” proposed leave a whole lot to be desired. As Mike Tyson observed, “Everybody has a plan until they get punched in the face.”

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  10. @Mark

    Dr Faber has argued that in particular that massive rise in the oil price was at least in part if not primarily a direct or indirect result of authorities

    Under the video are his slides for the presentation….oil pops up around the 6 minute mark if I recall correctly

    • I whole-heartedly agree Alister,

      It is the failed interpretaion and implementation of very simple instructions that leads to big trouble.

      The Fed’s job really isn’t difficult. They’re supposed to be cops. If you want to see a society implode, all’s you have to do is replace the cops with school teachers.

  11. You can always substitute fillet beef for pink slime processed sausage meat. Both are foods.

    Now how do we define the CPI shopping basket? Do we include goods and services people on fixed income with limited income bargaining power use or do we include items that wealthy people who can benefit from the Cantillon effect would purchase?

    Does it matter that we include consumer electronics in the CPI basket? They tend to drop in price and distort the effect of the CPI. The whole purpose of price stability is to protect the savings of those who may have retired, or are on welfare and can not increase their income rapidly.

    As I have mentioned in earlier posts, Economists and Statisticians are the tools of Politicians. We all know Politicians lie. We know that the CPI does not reflect reality. We have two party politics. These things are known but never questioned.

  12. What those in power do is change the conversation and keep a step ahead of the masses.

    For example, if you want to win an argument with someone, what you need to do it change the conditions which defined the initial discussion. Once you change the conditions, then you have changed the argument [hopefully in your favor].

    The next time you watch a debate, and if there are two accomplished debaters, what they will be doing is not arguing the points, but instead, attempting tho change the conditions.

    With the CPI, they attempt to change the conditions [what makes up the CPI]. Although it is obvious to those who understand a little bit about economics, it is completely lost on those who do not. Substituting hamburger for steak makes perfect sense to the average person out there who understands that s/he can not longer afford steak.

    Manipulation is what social behavior is all about. If it was about telling the truth, then there would be little reason to perpetuate any of the current social institutions. Government, corporations, schools, hospitals [which are not bad things in and of themselves] are used to separate people from the labor-valued earned, the penultimate goal of all social activity.

    After all, why else would people organize if not to steal from everybody else [of course, in the name of all good things]?

    • Hi Impermanence. You mention Labour value in your posts many times. How do we contribute to society i.e. provide our labour to eanr our place, when society is being overtaken by machines and mass production techniques? A serf earned his protection by the kand lord by providing hand labour to bring in crops. Industrial Revolution England and Current Chinese Industrial Revolution allowed the agricultural workers to find work, when replaced by machine farming techniques.

      If the mass produced commodities are going down in price, the standard of living for the poor is increasing. However once the poor own all the gadgets, there becomes a point where food, energy and other items that can not be produced cheaper through technology impact the fixed or non existent (Unemployed due to structural change) incomes of the poor, and they see a increase in prices. i.e. the CPI when measured against the weighted basket of goods that the Median worker consumes outstrips their labour value.

      Interest rates therefore, must be increased to put a break on speculative consumption and the Cantillon effect benefitting the rich at the expense of the Poor. For this reason I see the Negativive Interest Rate Policy NIRP, destroying the lower and middle classes buying power. The CPI for the poor IS NOT 2-3% which is the band preferred by Central Bankers. If the poor tried to save their labour value (Savings of their Capital) they are going backward unless they spend on current consumption.

      • “You mention Labour value in your posts many times. How do we contribute to society i.e. provide our labour to earn our place, when society is being overtaken by machines and mass production techniques?

        The problem isn’t technology, it’s the distribution of labor-value earned. There are many mechanisms currently in place that divert labor-value…government [taxes, fees, licenses, and the like], finance [mainly interest and fees], and those exacted through non-free market activities [monopolistic tendencies] that raise commodity prices.

        Add in all of the investment community’s scams, and dash of salt, a sprig of parsley, and you’ve got not so much left for the working man.

        Technology, which increases productivity, should be shared by all, as was the case in much of the 19th century where deflation ruled [money increased in value] and most people prospered as a result.

        I don’t believe that economics is something that can be understood. It evolves moment to moment as a result of its infinite variables doing their thing and seems to operate best when interfered with least [like all things].

        • Yes I agree, deflation is good, because the poor get access to more goods. i.e. TV’s and Computers can be picked up for free. People dump them on the nature strip out front of the house.

          Perhaps economics is like a patch of land. Left alone it will populate with plants then animals. A biosphere of diversity and health. Overfarm and manage it, you end up with one or two crops that tend to fail spectacularly.

  13. Great post! And many informative comments. I have long thought that the US government manipulates inflation data.

    Education is on the graph but not much in the post text or in the comments. It seems that higher education institutions in the US have recently (last decade or two) raised tuition and other charges and fees to whatever levels the market would bear, aided by the Federal government and its Student Loan programs. The repayment becomes in some cases an almost lifetime expense for those who have availed themselves of this ‘government benefit’.

    It is encouraging to see the number of efforts (some by educational institutions and others by private foundations) to enable young people to avoid some of this unnecessary expense by offering low-costs college credit courses on the internet. Much of the expense to get basic college requirements can be done in this manner. I’m not aware of where the Federal government has been involved in this effort which seems to me laudable.

    • The same is happening in Australia.. Higher education costs with a lower standard of education (It is well known that Professors pass students to keep the University full)

      I did the Tax Return of a High School Principal, who was the “Change Leader” in a number of High Schools that merged. I asaid why did they get rid of the dedicated Technical Schools (Trades like Mechanics Caprentry, Foundry sheetmetal etc) and merge them with a “dumbed down” High school (Less emphasis on Grammar and English Literature) He said it was too expensive to pay for technical teachers and machines for the students.

      Now we have a skills shortage in our heavy trades and mining, and we have to import workers. The foresight of these “Change Leaders” is pathetic. This causes the price of labour to shoot up in costs such as Housing construction, which then effects the poor’s ability to purchase a roof over their head. But this metric is not included in our CPI. If it was Interest rates would ave been 10% instead of 6%, and would have popped the speculative housung bubble in Australia.

    • The same is happening in Australia.. Higher education costs with a lower standard of education (It is well known that Professors pass students to keep the University full)

      I did the Tax Return of a High School Principal, who was the “Change Leader” in a number of High Schools that merged. I asaid why did they get rid of the dedicated Technical Schools (Trades like Mechanics Caprentry, Foundry sheetmetal etc) and merge them with a “dumbed down” High school (Less emphasis on Grammar and English Literature) He said it was too expensive to pay for technical teachers and machines for the students.

      Now we have a skills shortage in our heavy trades and mining, and we have to import workers. The foresight of these “Change Leaders” is pathetic. This causes the price of labour to shoot up in costs such as Housing construction, which then effects the poor’s ability to purchase a roof over their head. But this metric is not included in our CPI. If it was Interest rates would ave been 10% instead of 6%, and would have popped the speculative housing bubble in Australia.

  14. I thought the best way to measure inflation would be through disposable incomes. Get people that are representative of the whole economy, and track their incomes and how that changes over time. Thats ultimately what inflation is about isnt it?

    • I agree. One thing that bugs me with Union wage demands is people on 80,000 a year want a 3-4% pay increase, but their cost of living is only $25,000, so they are getting a increase on the “disposable” part i,e, savings. This causes exponential CPI increases.

  15. Discussing the accuracy of inflation measures would be like debating the actual design of calipers used to measure the bullet that just scattered somebody’s brains all over the room.

    Although of academic interest, perhaps, it really doesn’t get to the heart of the matter, i.e., why this atrocity occurred.

    You go to the store to buy something. If it cost more than the last time you bought it [all things being equal], it’s price inflation. What else do you need to know?

    All institutions are going to lie to you. It’s what they do to perpetuate the great lie, as it is the internalization of this reality that makes one a “trustworthy” adult.

  16. Fees would be an interesting thing to examine as part of inflation, although it would be difficult to comprehensively or meaningfully graph it. I am thinking about the commuters to NYC who paid $8 for a number of years to cross the George Washington bridge, which jumped up to $12 last year. A lot of rising fee expenses certainly are felt by people and are part of the common sense definition of what inflation is.

    • A good point. The price of weekly living expenses i.e.. fuel, fees, travel costs i.e. fixed costs to earn a living should be weighted higher, and gadgets that go down in price, either removed (You can buy a cheap TV or Video or iPod second hand quite easily) or severely weighted down. Price movement may be volatile for fuel, but the annual CPI needs to be based on the average price of fuel for the year, which usually smooths out market speculative swings and picks up actual costs of production.

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