More Trend ‘Hustle’

From the comments of Scott´s second reply to David Andolfatto:

David Andolfatto:

Scott, that trend decomposition provided by Darda is embarrassing. Looks like he just picked his start point. And more important, that blip in 2008 was entirely energy prices. Nobody expected that to be permanent. If you take the blip out, then the actual inflation path runs underneath the blue trend line since 1998.

Scott Sumner:

That price of oil was based on the China boom and (at the time) no knowledge of the giant global recession on the way. You are saying it was a bubble? And yet we’ve had a catastrophe in Europe that no one expected, and still gasoline is back over $3.50 a gallon. Where would oil be today if the US and European and Japanese economies had not tanked?

I would add that your comment is wrong for another reason. He ran his trend line through 2007, when oil prices were about the same as today, not 2008.

Mark Sadowski shows this measure of supply (price) shocks

and says:

It’s not that difficult to imagine a scenario where an economy is hit by the third largest negative AS shock since WW II. And the central bank passively tightens monetary policy in order to stabilize the price level causing leverage to rise high enough to cause a financial crisis.

And Mark is absolutely right.

Note that the fourth largest shock occurred during Greenspan´s last couple of years as Fed Chair. But instead of saying, as the Bernanke FOMC said all through 2007 and up to September 2008, that there was a high risk of rising inflation (for example, as late as August 2008, the Statement said: “Inflation has been high, spurred by the earlier increases in the prices of energy and some other commodities, and some indicators of inflation expectations have been elevated” with one dissenting vote that asked for an increase in rates), the Greenspan FOMC, at the peak of oil prices in September 2005 said in the Meeting Statement:

Higher energy and other costs have the potential to add to inflation pressures. The Committee perceives that, with appropriate monetary policy action, the upside and downside risks to the attainment of both sustainable growth and price stability should be kept roughly equal. 

I love the phrase “appropriate monetary policy action”. It´s saying “Don´t fret, we´ll do the right thing to keep the plane on course”!

So with the benefit of hindsight David Andolfatto shrugs off the very real worry about inflation the FOMC displayed at the time. And by being an inflation targeting nut Bernanke was instrumental in leading the MP tightening.

And it doesn´t matter if you run your trend line to mid-2008 as David Andolfatto has done, or 2007 as Scott prefers or even to mid-2005 as the chart below does. That´s because the ‘inflation hump’ will not go away and that was the ‘trigger’ for Fed tightening (passive or active).

It´s really much better to be guided by core inflation. As the charts below show, there´s no ‘inflation hump’ regardless of where the trend stops. In the top chart the trend is run up to mid-2008 and in the bottom chart to mid-2005. They are indistinguishable.