Santa, it´s not more inflation we want. It´s more Nominal Spending

Bloomberg tells us “A Little More Inflation Would Be Good for Everyone”:

Thirty years ago, any policy maker would have welcomed a run of inflation below 2 percent. But the less inflation there is, the lower central-bank rates will be, making a return trip to zero more likely. That would force officials to resort, once again, to unconventional tools such as bond-buying that can be politically unpopular and less effective in restoring jobs and growth.

“We’re not saying goodbye forever to the zero lower-bound and the problems that it causes,” former U.S. Treasury Secretary Lawrence Summers told Bloomberg on Dec. 15. “When we get to recession, we usually need 300 basis points or more of Fed easing, but there’s simply not going to be room for that.”

Those are not good arguments. The charts show that:

1 There´s not much difference in the behavior of inflation in 1996-04 and 2010-15. In both instances they were mostly below “target”. But no one worried about “too low” inflation 10 or 20 years ago!

2 The big difference is in the behavior of nominal spending (NGDP) growth and its level


It seems, therefore, logical to root for an increase in the level of spending followed by a stable growth rate (open for discussion are the establishment of both the target level of nominal spending and its stable growth rate)

And as the charts also indicate, that´s a job the Fed can do if it sets its mind to!

The labor-market´s double burden

First it has to gauge how close the economy is to the first mandate (maximum employment) and is then used to predict the second mandate (the inflation rate).

That strategy derives from the Fed´s (and Yellen´s) firm belief in the Phillips Curve, the theory that there is (in some form) an inverse relation between the unemployment rate and the rate of inflation.

But, naturally, there isn´t. So the Fed is “chasing rainbows” and, apparently, wants to continue to do so.

They could take a leaf from Nick Rowe, and start acting very differently:

The business cycle is a monetary exchange thing.

Which would tell them they are on the wrong track!

On the CPI

A James Alexander post 

We have written on the causes of the oil price collapse and why it isn’t very good news, mostly just a consequence of falling AD, or at least a lot less fast growth in AD than expected.

US CPI showed it bouncing along the bottom again in November 2015 .Yet we have to put up with the usual charts of CPI excluding volatile items like food and energy – or anything not going up fast enough to prove the inflation-phobics right.

When CPI is high this asymmetry of reaction is sickening as the inflation-phobics worry about the public being fooled by temporarily high oil prices (or whatever) into thinking a high headline will translate into an unanchoring of inflation expectations. Unanchored inflation expectations are, apparently, incredibly dangerous as they are assumed to directly drive inflation into a never-ending upwardly vicious circle. Only counterproductively aggressive Fed action could prevent this situation from getting out of hand.

In fact, successful monetary policy should un-anchor inflation expectations: how else will velocity of circulation be driven upwards to drive NGDP higher when necessary? It’s a feature of monetary policy not a bug. It is also known as the hot-potato monster.

When headline is low all the experts “know” it’s going to bounce back and few worry about the downside of unanchored inflation expectations. Suddenly the public is trusted to keep their expectations “well-anchored”. Mean reversion is a fact, isn’t it?

This is all highly confusing. But will headline inflation really bounce back up as the Fed and mainstream macro forecast? For sure, as the drops in energy prices must eventually come to an end they must also eventually drop out of headline inflation indices. But if the energy price drops are mostly a symptom of weak demand, as Market Monetarists suspect, then at least part of the faster rising prices in other parts of the economy are also temporary as consumers resources are only redirected in a one-off move, and those non-energy prices must also slow. “Core CPI” will thus fall back to headline CPI and not the other way around.

One way to look at this is to assume 100 total money units and that velocity is constant. Assume 20 units are of money are spent on food and energy and 80 on “other items”. If the price of food and energy drops by 25% and the demand curve is inelastic, 15 units will be spent on food and energy and 5 units redirected to chasing “other items”. If there is no additional money injected into the economy the relative increase in demand for “other items” will be seen as just a redirection of resources. No new “other items” are produced and the producers of the “other items” will just take the gain off the food and energy producers, thank you very much. The overall price level will remain unchanged as will overall production.

If we constructed a core “other items” price index then we would see inflation of nearly 6% (5/85). But should monetary policy really be changed just for a core items index temporarily inflated by a fall in prices elsewhere in the economy? Of course not.

The numerous alternatives for core inflation show a lovely, but inevitable, range around the headline 0.5%, and you can make a good case for any of them. Shelter is a particularly good candidate to be excluded given the complexity of creating a reliable index of actual rent for a whole economy and the even tougher task of creating an index of Owners Equivalent Rent for the majority of households who are owner occupiers. This latter group’s assumed benefit takes up 25% of the CPI basket with their “benefit in kind”. Excluding shelter, inflation was a negative 0.8% YoY in November 2015. Sure “services” inflation is 2.5% but services less shelter is only 1.8%. And only 30% of the total basket.


It is the same for regions of the US. Some metro areas have inflation over 2.6% YoY, but so what? Others are in deflation. It’s one economy, one aggregate. Some go up, some go up less, some are flat and some go down. How could such a large economy as the US be anything else?


Those who focus at present on non-food and energy inflation are kidding themselves about an impending inflation take-off given NGDP is rapidly slowing and the Fed has been on a passive tightening bias for a year or more and is now actively tightening.

The Fed is “data-independent”

Otherwise, they wouldn´t be so vocal about “the time has come”. Especially given the information coming from the inflation data. With oil price high or low, inflation was falling and remains too low!

Data Independent_1

What is clear is that nominal growth has been too slow, keeping both real growth and inflation below what could be, at point a instead of point b.

Data Independent_2

Calling Arthur Burns

A Benjamin Cole post

Where is Arthur Burns when you need him? Burns was the mousy U.S. Federal Reserve Board Chairman from 1970 to 1978, the last man in America to part his hair in the middle, and the central banker who infamously presided over double-digit inflation. Burns actually posed for official portraits with a pipe thoughtfully in hand. For you youngsters, that is a smoking pipe; he wasn’t a plumber.

At any rate, back in the disco-1970s Burns held that the powerful market players of the day—unions, the Big 3 automakers, Big Steel, Big Retail, etc., would cut output but not prices, if monetary policy was tightened.  Other industries were rate-regulated, including transportation, telecommunications and banking. Even stockbroker commissions (very fat!) were regulated by law, and there was little international trade or competition.

Burns was successful in many regards; recovering from the 1973-75 recession, U.S. real output expanded by 20% in just four years. You read that right—20% real growth. That is a grand slam.

But, as measured by the CPI, inflation hit 13.3% in 1979.

Subsequently, Burns’ reputation was all but ruined by Chairman Paul Volcker (1979-1987), who raised interest rates sharply and crushed inflation back to under 5% in a few years, and then declared victory (yes, anything under 5% inflation was fine in those days. BTW, the NeoFisherians need to ponder Volcker).

Burns thereafter was inducted into the Economics Hall of Shame.


Today the economy is far less inflation-prone than in the 1970s, what with unions dead, and the Big 3 and Big Steel desperately fighting for market share, a web-infested retail sector, and globalized economy. How much has the world changed? New motor vehicle prices have not changed in 20 years.

Burns could have a field day!

But there is a fly in the ointment. Today the housing market has emerged as a sector immune to inflation fighting. As blogger Kevin Erdmann has pointed out, the U.S. is a nation with ubiquitous property zoning, and consequent artificial housing scarcity. Politically, this is a dead end. First, zoning is local, so there is nothing the Fed or Congress can do about it. Secondly, powerful homeowner groups crave retail-free single-family detached housing districts, and highest-and-best-use be damned to hell. Thirdly, many urban neighborhoods have character, a feel that has attracted residents, who have slavishly gentrified entire districts. Soviet-style apartment blocs might solve the urban housing problem, but few want such fixes—in their neighborhood.

Burns would have recognized that housing, now 40% of the PCE deflator, is immune to tight money—and thus he would print more money, and tolerated some inflation. Today, would Burns be right?

Probably. After all, PCE core inflation is running at 1.3% and falling. Unit labor costs have hardly budged since 2008. Forget computer prices. Copper is selling for the same as 10 years ago.  The rest of the developed world is fighting deflation, not inflation.

It is time for a rehabilitation of Arthur Burns.

Yes, I still prefer nominal NGDPLT. Or even an IT band of 2.5% to 3.5%. But I would take Burns over today’s FOMC in a heartbeat.

PS Forgotten today is that Arthur Burns was one of two professors that Rutgers student Milton Friedman said inspired him to be an economist. Later, Friedman followed Burns to the NBER, and after tutelage by Burns, Friedman wrote his classic work A Monetary History of the United States, 1867–1960. After his stint at the Fed, Burns went on to hang his hat at the right-wing redoubt, the American Enterprise Institute. Surely, Burns can be rehabilitated, and his policies brought to bear in modern-day America.

Like any good compass, the Fed´s inflation compass always points north!

In this Bloomberg Business piece, aptly titled “Everything Except Headline Inflation Is Saying the Same Thing About Inflation”, we read:

There are dozens upon dozens of ways to measure inflation, which at times means that monetary policymakers might be receiving conflicting signals on how much upward or downward pressure on prices there really is.

But after October’s Consumer Price Index report, most gauges of prices are all pointing toward the same thing: inflationary pressures that are far more consistent with an economy that’s on the verge of a tightening cycle than one slated to enter a deflationary spiral.


“There is not a lot here to be very happy about if you want the Fed to stay on hold,”wrote Michael Ashton, managing principal at Enduring Investments. “The only argument that is stronger now is that they are even further behind the curve.

Which closely mimics Richmond Fed president Jeffrey Lacker, quoted in this other Bloomberg Business piece:

Richmond Fed President Jeffrey Lacker, who votes this year and dissented in September and October in favor of a rate rise, told CNBC in an interview that strong growth in consumer spending showed the economy needed higher real interest rates.

There’s a chance we’re going to get behind the curve” if the Fed delays liftoff, he said.

The first piece above shows a version of this chart to indicate the ominous presence of inflation.

Fed Compass_1

But, lo and behold, in early 2008, if BB wrote something, it could have exactly the same title: Everything Except Headline Inflation Is Saying the Same Thing About Inflation”, only with the meaning reversed.

The correspondent chart:

Fed Compass_2

Common to the two periods is the fact that monetary policy was being tightened as gauged by nominal spending (NGDP) growth.

So, no matter the fundamentals, to tighten is the Fed´s default option. It doesn´t matter if oil prices are on a roll or on a chute!

Fed Compass_3

Much ado about very little. Inflation day blues

In the recent “Explaining Low Inflation: Model-Based Decomposition”, Saeed Zaman goes through a lot of trouble to find that:

While simple, the forecasting model used in this analysis was able to explain most of the falloff in core PCE inflation over the past four years as a response to other developments in the economy.

According to the model, the sluggish pace of labor market recovery in 2012 and 2013 had been restraining core inflation along with lower energy prices. But over the past year or so, the sharp falloff in energy prices and the rapid appreciation of the nominal dollar have acted to significantly restrain core inflation, while the labor market has been putting some upward pressure on inflation.

Historical experience suggests that the impact of both temporary energy and dollar shocks on core inflation is usually short-lived. Therefore, to the extent we are confident that economic activity will continue to increase moderately and slack in labor markets will continue to diminish, these factors should put upward pressure on inflation during the next few years, as we forecast inflation to rise at a very gradual pace.

OK, OK. I find “able to explain most of the falloff in core PCE inflation over the past four years as a response to other developments in the economy” a time-honored argument. After all, back in the high rising inflation of the 1970s, Arthur Burns could say with a straight face that the rise in inflation (core PCE, whatever) was also a response to other developments in the economy. In that instance to the power of trade unions, oligopolies and oil producers!

Mr Zaman just doesn´t see monetary policy having much to say in the matter. The chart could be interpreted as calling-out his conclusion!

Inflation day blues

Note that inflation even stops falling when nominal spending growth backs-up just a bit, only to resume the down trend when NGDP growth once again falters.

Couldn´t Mr Zaman, along with a host of other analysts and researchers, as well as with the top brass at the Fed, look at the problem from another perspective and conjecture that just maybe, “other developments in the economy” (the exchange rate, oil prices, labor market weakness) and low inflation, could all be responding to inadequate and tight monetary policy?

Headline CPI could now stay below Core CPI for 10 years

A James Alexander post

The inflation doom-mongers are out again with today’s US Consumer Price Index numbers and, to a lesser extent, in the UK where, headline inflation really is just too low for most hawks to shout too much about steady core inflation.

We must all ignore “headline” inflation and focus on “core” inflation. Core is the measure for inflation-worriers because … it is currently higher than headline. When headline was above core they worried about headline, naturally enough. Normal service will be resumed as there will be a very short period before headline inflation goes back above core inflation, pulling up the latter. But will it?

In the UK everything about CPI (and the RPI in its former life) has to be taken with a large health-warning since the index is not a proper economic statistic because it is never revised, but it remains a very politically and financially sensitive one nonetheless.

UK headline inflation (CPI All Items) was above core (CPI excluding food, energy, alcoholic beverages and tobacco) for ten years in a row before falling below core one and half years ago – by an average of 70bps per annum. Some feat. Although this does include 2008 (the notoriously heavily revised year for proper economic statistics) when the gap was 200bps.

The story in the US is much the same. Although it looks as if headline bounces around the core trend, for the same 10 years (2003-2013) as in the UK headline was 50bps above core inflation.


Is there any reason not to think that we may have ten years of headline being below core? Not really. These things should be fairly random and even out over the very long term. But you just know the inflation-worriers won’t be pointing this out.

They will still be looking when hell freezes over!

Today´s PPI:

Overall producer prices decreased 1.6% in October from a year earlier, the 10th straight year-over-year decline and the biggest annual fall since the government started publishing the series in 2009. Core prices were up 0.4% from a year earlier.

Those gauges have been historically weak this year amid low oil prices, a strong dollar and weak demand abroad.

Federal Reserve officials are looking for evidence of firming inflation before they raise interest rates from near zero, where they have held since 2008. Officials have said they want to be “reasonably confident” inflation will move toward the Fed’s 2% target before liftoff.

However, “low oil prices (note that it´s not falling oil prices anylonger), and a strong dollar” are the consequence of weak domestic demand (falling NGDP growth). Weak demand abroad is partly due to weak demand in the US!

Don’t base monetary policy on unreliable data

A James Alexander post

Scott Sumner, like many, was very taken with the latest average hourly earnings figures. The tick-up seemed to be breaking a very dull trend and taking the growth rate back up to the heady heights of 2007.

Unfortunately, the series he used – average hourly earnings for all private sector employees, seasonally-adjusted – only goes back to 2007. The much more traditional series for private sector non-supervisory and production employees goes back to 1965. This chart is perhaps a better guide to the long-run trends. It is far harder to spot any significant trend breakout.

JA Wage Growth_1

Also, the bigger data set includes many more service sector employees where hourly earnings aren’t a particularly relevant measure of pay. There are 120 million total private sector employees, but only 20 million of them who are outside (above?) the non-supervisory and production category.

It should be a simple matter to check the average hourly earnings of the 20 million supervisory and non-production workers but it isn’t. There doesn’t seem to be a dataset released for that, indicating to me at least that it isn’t a robust data set. It’s not on FRED and it’s not even on the Bureau of Labour Statistics website. There are some (very old) discussions about how the hours for this segment are calculated, but not a lot of recent statistical material, if any. I think this makes it highly dangerous to rely on the all private workers average hourly earnings growth figures.

The seasonal adjustments may also be harder to do and often lead to large revisions. The non-seasonally adjusted version of Scott’s chart looks a lot less compelling.

JA Wage Growth_2

In the absence of any guidance from the BLS that I can find I did a some simple calculations to find out the average weekly pay of the “white collar” employees. It is more than twice that of the “blue collar” staff.  And the gap must be growing given the recent trends in the two indices in the first chart. If I was to derive a longer term chart for the growth in “white collar” average earnings per hour then I bet I would find a very volatile series indeed. The question is then: should this highly volatile, not particularly robust, sub-series drive monetary policy? Of course, not.

JA Wage Growth_3

All this discussion is a bit beside the point given the horribly low and lower overall inflation figures and the negative growth  in US$ base money. The Fed is still wedded to the output gap/Philips theory of inflation and it has been proven wrong – no respectable mainstream economist who believes in basic macro would have predicted a halving of the US unemployment number without a major rise in wages. They (and the central banks) need to rethink their macro, it is time for them to ‘fess up and stop worrying about such ad hoc concepts as “secular stagnation”. Just as the inflationistas have had to rethink their understanding of macro – I should know, I used to be one. Money drives nominal growth and wages, and good nominal growth allows strong real growth.