CPI Overstates Inflation? Puh-Leeze!

Larry Kudlow has been flogging my Ben Bernanke as Neville Chamberlain quote for weeks now. So why do I think Ben Bernake is dovish on Inflation?

His view of CPI data.

Setting aside the rest of the dismal scientists idiotic obsession with the core rate of inflation, no one (outside of academia) is persuasively arguing that prices across a broad cross section of goods and services are not going higher, or the purchasing power of the dollar has slipped. One top of that, the supply demand equation continues to see the printing presses working overtime, further eroding dollar strength.

I cannot find it at the moment, but
prior to my “Neville Chamberlain” remark was some commentary by Fed Chair Ben
Bernanke’s that the CPI overstated inflation.  That’s what led to
my painting him an inflation dove.

Today, we see once again a the same idea. In a letter to JEC Chair Jim Saxton, Fed Chair Bernanke reiterates the idea again. 

"Most analysts believe that changes in the CPI overstate changes in the cost of living to some extent . . . The PCE price index likely is also biased upward, though probably by less that the CPI in light of PCE’ measure’s advabtages cited above.

Although increases in energy proces have pushed up overall consumer price inflation over the past couple of years, core inflation has been more stable."

In case you were wondering, I find this nonsensical.

>

Source:

BERNANKE’S ANSWERS TO SAXTON’S QUESTIONS RELEASE
Letter from Fed Chair Bernanke to Jim Saxton, Chair, JEC
May 24, 2006
http://www.house.gov/jec/news/news2006/bernanke statement 05-24-06.pdf
(see page 5 of PDF)

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What's been said:

Discussions found on the web:
  1. vf commented on May 26

    yep no doubt Bernanke is scaring some folks including myself.. i think his intentions of transparancy are good but he will likely find himself behind the curve as the market is discounting the future and the data he’s looking at is lagging.
    interesting that the Eurodollar strip, one the largest most liquid markets in the world, is not really discounting a June tightening but the bond market which is equally as liquid has been flattening suggesting that the long end is looking for tightening. the dollar looks like it could move either way. next Friday’s employment data could make things very interesting.

  2. trader75 commented on May 26

    Gentle Ben has been imprinted like a duck with the mental image of soup bowls and bread lines… if his career fascination had been with the Carter years, we’d be in a different place now.

    —————————————
    Study of Great Depression shapes Bernanke’s views

    Wednesday, December 07, 2005
    By Greg Ip, The Wall Street Journal

    In 1983, Mark Gertler asked his friend and fellow economist Ben Bernanke why he was starting his career by studying the Great Depression. “If you want to understand geology, study earthquakes,” Mr. Bernanke replied, according to Mr. Gertler. “If you want to understand economics, study the biggest calamity to hit the U.S. and world economies.”

    Mr. Bernanke’s fascination with the economic earthquake never abated. “I am a Great Depression buff, the way some people are Civil War buffs,” he wrote in 2000. “The issues raised by the Depression, and its lessons, are still relevant today.”

    Mr. Bernanke’s interest in the Depression, which dates back to his childhood, is a guide to the evolution of his thinking. In particular, his groundbreaking research on how mistakes by the Federal Reserve compounded the catastrophe is likely to influence how he steers the economy once he succeeds Alan Greenspan as its chairman early next year…
    —————————————

  3. JBR commented on May 26

    I laughed yesterday when I saw that too, about the CPI overstating inflation… What world does he live in??

  4. Barry Ritholtz commented on May 26

    I grew up during the 70s, so my bigger views were “shaped” by double digit inflation.

  5. jab commented on May 26

    transparency = volatility; Greenspan for all his faults especially in the second half of his term understood this.

    I tried to give Ben the benefit of the doubt but the guy’s lost me after only a few months.

    However, I believe Ben (and Al) know there is inflation and is trying to convince everyone else there is not any so he can keep the printing press rolling.

    Difference is Al had credibility with enough to pull it off … Ben does not.

  6. Alaskan Pete commented on May 26

    Barry you’re behind the curve dood. I posted that Bernanke/Saxton understating bit in your comments yesterday. Try to keep up mang, lol.

  7. jcf commented on May 26

    I was around in the Depression and the ’70s with their Elvis sideburns and polyester suits were a Bacchanale in comparison. Not a hint of teetering at the precipice. Take a look at Let Us Now Praise Famous Men. Give Ben credit for having a heart.

  8. I Love Everything commented on May 26

    the great hedge fund bust of 200X

    this guy manages a HF and he’s been relentlessly bearish for quite some time. Tippy toes, folks. I put all my mutual fund dollars into international/emerging markets about a month ago because I don’t like this scene, but it’ll be fun to watch.

  9. Robert Cote commented on May 26

    New Fed definition of core CPI: Anything that doesn’t go up in price.

    Makes perfect sense, since there isn’t any inflation putting silly items like healthcare, tuition, healtcre, etc. in the formula would send false signals. Heck, if you measured my breathing only on exhalation you could resonably assume I produce atmoshpere. Indeed, every time I breathe out my lungs DEFLATE.

  10. ndk commented on May 26

    JCF… thanks for the perspective.

    Given the promises America’s made that it can’t keep — to its creditors, to its people, to its retirees, to itself — as a humanitarian, personal matter, I strongly prefer inflation to grinding debt-deflation as a way out of this mess.

    Inflation may be destructive, but at least it’s an egalitarian process.

  11. donna commented on May 26

    Funny how people tend to bring about that which they most fear… well, let’s hope not in Ben’s case, then…

  12. SC commented on May 26

    if people start to rent @ 2500/mos. rather than buy @ $3200/mos. , is this deflationary?… what if the rent moves to $2500/mos. , does this become inflationary ?…. the argument is that the $2500 is still less than $3200 , thus deflationary…. more people renting @ $2500 vs. people owning @$3200 will change the inflation #’s …. tantamount to people buying chcken @ 89-c /lb rather than beef @ $3.99/lb. , the change in consumer appetite will be deflationary….

  13. GRL commented on May 26

    I really think that you should take a good, hard look at the BIS working paper that was behind a Martin Wolf newspaper piece that someone linked to a few days ago.

    http://www.bis.org/publ/work205.pdf

    It really is a point by point critique of the whole concept of “inflation targeting,” with a few jibes at the CPI and other “macro” measurement tools thrown in for good effect. In fact, at one point, the paper specifically cites to Bernanke in the following passage, which says it far better than I can:

    Should the economy then turn down, with inflation initially at a very low level, the possibility then arises that a more disruptive form of deflation might emerge. Were that to happen, it has been suggested that an even more “unconventional” monetary policy stance than that applied in Japan would be called for, with all its associated uncertainties. [footnote to Bernanke here] That this was the end point to which the conventional way of conducting policy almost led us would, in itself, seem a powerful argument for further refining [ie., changing: ed] the basic framework.
    (emphasis added)

    In one of your earlier posts, you said that, after the current mess hits the fan, “inquiring minds will want to know” who was right and who was wrong, who needs to be held accountable for their mistakes. Well, I think one of the entities which will be held accountable will be the Federal Reserve, and this BIS working paper lays out in considerable detail a preview of the form I think the accountability will take.

  14. jken commented on May 26

    i just sold my condo and now rent for $3000 / month…before i was paying $4200 for mortgage and maintenance… the rent was $2850 three months ago so i’m paying more than that , but i’m still saving $1200 / month than i did the last 2 years…. is this inflation?

  15. maybe commented on May 26

    That’s a good point on the rent vs. own …. what do you think Barry ???

  16. KL2005 commented on May 26

    Back in Economics classes in college I remeber learning you can not calculate inflation you can only bound it. Either you overstate or understate inflation. The USA chooses to calculate inflation using the upperbound methodology (overstates inflation)

    If you disagree with Ben then you are saying someone is manipulating the data or they are so inept at picking and calculating the basket of goods they track.

    The only legitimate (not picky) complaint I have read about is when they went from home ownership to cost of rent that was years ago, but does understate inflation due to recent skyrocketing housing prices.

    To be fair Ben is mostly correct. This is true even if you do not like the answer. Simply sighting higher costs for oil etc does not make you correct. There are plenty of stuff that has not risen or even plummeted (cell phones, long distance , etc.)

  17. tw commented on May 26

    My new Dell just cost me $1200 vs. 3 years ago @ $2200… is this inflationary ?

  18. me commented on May 26

    “My new Dell just cost me $1200 vs. 3 years ago @ $2200… is this inflationary ?”

    Depends, since it is a Dell, it probably won’t last 3 years like the last one.

  19. FliteTime commented on May 26

    Hey ‘tw’, that’s not inflation. It’s supply overcoming demand, coupled with competition and cheaper component costs (to Dell).

    Back to Bernanke, I just learned about Hedonic Pricing last night, and that it is the favorite method to create the CPI numbers & other Federal “statistics”. To say the CPI overstated inflation is basically saying that not enough “intangible benefits” were brought into account.

    See, you guys are presenting actual, hard numbers (rent vs. mortgage) and asking if that’s inflation. But, I think the Fed would prefer to tell you that your rent isn’t going up because “you live in a better house, in a better neighborhood” now, even if you didn’t move! Therefore, they claim that there is no inflation.

    Either that, or Big Ben is just trying to keep us guessing on his next move. It’s all a game.

  20. jab commented on May 26

    Some Comments on Inflation Calculation

    Beyond the fact they bluntly exclude Food & Energy from the Core Rate {Ignoring major items that go up in price} they manipulate inflation in many ways:

    1 – They totally exclude housing and only use rents. While extremely low rates made housing prices take off this never made it to the Core Rate. In fact this kept rents depressed and hence had the opposite effect in the Core Rate – Rising home prices brought the Core Rate down!

    2 – The substitution effect stated above is classic. Now people eat chicken instead of steak because steak went up in price. Again the rising steak prices brought the Core Rate down!

    {Are we getting the “Big Picture” yet – Rising prices bring the Core Rate of inflation down.}

    3 – Hedonic adjustments – Since a light bulb last 10 times as long it has had a 90% deflationary effect on the Core Rate. Lots of examples of this in the calculation.

    There are others but one other thing to keep in mind I do not see mentioned often:

    Since the Core Rate of inflation is Understated by definition the Real Rate of Growth must also be Overstated! So when we are supposedly growing at 3% we are probably just staying even.

  21. tw commented on May 26

    the rent vs. ownership example is the best point on the whole blog if the quality and footage of housing’s the same …… thus the CPI overstatement “is” overstatement … and the Dell example is obviously deflationary …. and real GDP is “net” of inflation , therefore it is “real” @ 5.3%… the Dell example is another point to why there are many deflationary , hedonic examples…

  22. B commented on May 26

    TW , u make some good points

  23. Blissex commented on May 26

    Well, this is the usual talking about different things…

    The BIG question is: inflation of what?

    Because some prices go up and some go down, and if ”inflation” is an average, and is an average of a distribution with more than one peak, it does not mean a lot.

    My impression is that Greenspan and Bernanke and others really track is not a basket of consumer goods.

    What they worry about is really wage inflation, and of course they can’t say that, so the CPI gets dutifully dissembled.

    Even the logic behind ”Hedonic adjustements” is about that: are wage earners still able and willing to trade down instead of fighting for wage increases?

    As long as low and middle range wages are static or falling everything is fine. That’s the inflation that matters to some people.

    Secondarily since the CPI drives COLA in wages and pensions, keeping a low CPI actually keeps the inflation that matters down, instead of viceversa…

  24. Bharath commented on May 26

    Anirvan Banerji’s (of ECRI) position on this seems to explain why there is so much confusion on whether or not there is inflation. ECRI has a good track record with their Future inflation guide. And it sounds like he’s not sure whether inflationary pressures have eased or not.

    http://www.thestreet.com/_tscs/comment/investing/10286423_2.html

    “Yes, Aaron, we’re in a cyclical inflationary cycle in the midst of a secular disinflationary cycle (deflationary in some sectors) — but that cyclical upturn in inflation started a couple of years ago. The real question is not where we are, but where we’re headed, and for an answer, it’s no good looking at coincident measures of inflation, whether based on the CPI, core CPI, or core PCE deflator. This is why we look at ECRI’s forward-looking Future Inflation Gauge, or FIG, which anticipated the cyclical upturn in inflation and kept rising through last fall. It has eased off a bit since then, but I’m keeping a close eye on it to gauge whether the easing in underlying inflation pressures is real and sustained. ”

  25. Idaho_Spud commented on May 26

    I too have a hard time with the suggestion that CPI overstates inflation.

    Core CPI nicely captures the prices of all the items that arent’ necessary for survival (eg discretionary items like the Dell example above), but even that CPI number is going up at an uncomfortable clip.

    The routinely ignored Headline CPI is more akin to what the US consumer faces every paycheck, and even that is understated. The world is awash in $US (the *real* inflation). Is there any wonder prices are going up?

  26. muckdog commented on May 26

    I think those talking about inflation have their eyes on the wrong ball.

    With interest rates rising and energy prices high, my feeling is that the risk facing us is a slowing economy and potentially a recession. Especially if the Fed doesn’t stop doin’ what it’s doin’…

    Recessions aren’t inflationary.

  27. kennycan commented on May 26

    The Dell example misses a key point about inflation.

    Yes, Dell sells a computer for a fraction of the price it had 3 years ago. But absent inflation wouldn’t that price be some fraction lower?

    There is one question that is not being asked enough. Given the deflationary trends we have seen over the last 15 years – tech advances, integration of vast labor supplies into the capitalist system (China/India), advents of free trade zones in Europe and North America and elsewhere, etc – why is there inflation at all? If all these factors are working to lower prices, then what is working to raise them? Whatever CPI you think is correct, core 2.1% nominal 3.4%, “old school” 5+%, or Bernanke 1%(?), why is there a positive number in front of that x%?

    That’s why we have an inflation problem. The world should be a better place because people should be getting the benefits of lower prices for things. In the West that means better living standards. In developing countries that means being lifted out of poverty (and to be fair that is happening, just not as much as it should). In some places that means life or death. That is the real cost of this dog-not-barking inflation.

  28. Paul Jones commented on May 26

    When you are a first time dell buyer you are buying computational power, when you buy a second dell you are paying for a slight increase in computer power (marginal utility), many households are not willing to pay current prices for upgrading which is why the PC market is in disarray.

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