Just a quick illustration of why I — along with the Fed and everyone else who’s serious about these things — use core inflation rather than headline inflation to measure trends. Here’s core versus headline CPI growth for the past decade:
So, do you believe we faced runaway inflation in early 2008, which had turned into runaway deflation by the middle of 2009, then miraculously stabilized? I don’t; I think volatile prices were volatizing, but that underlying inflation was trending steadily downward."Everyone else who's serious about these things?"--oh, you smug sonofabitch... Okay, that aside, the Wall Street Journal immediately posted a rebuttal (imagine that).
As you can see, the headline CPI item is incredibly volatile, but seems to hew to the core measure over time.
But that isn’t the entire story. Here’s another chart showing the cumulative change in the headline and core CPIs since the end of 1999:
The core has risen 24.1%, the headline has risen 29.4%. So except for those supermodels who don’t drive or eat, prices have risen more over the past decade than the core measure suggests.
That’s not to say the core isn’t generally a better guide to understanding what’s going on with underlying inflation; rather that there may be something going on with those noncore measures that is worth paying attention to. For example, rapid growth in developing markets may be bringing about a shift in global demand for commodities such as oil and grain that makes it unlikely that their prices will revert to the mean.The line about supermodels, while snarky, is an important one. It dovetails nicely with an e-mail response that I sent to a reader (my mother-in-law) this morning, after she had sent me a link to this New York Times article.
As I wrote in my e-mail, my greatest fear is of "biflation", which is EXACTLY what the Journal's graph is showing. What Krugman chooses to refer to as "underlying inflation" is realistically durable good inflation--autos, technology, etc. This portion of goods represents 90% of income for the richest 20% of Americans, but only 40% for the poorest 20% (refer to the chart in this post for a stunning graphical representation).
So for the poorest Americans (Princeton professors need not apply), which is realistically the more important measure of inflation? The one that tracks their ability to eat and heat their homes, or the one that tracks their ability to buy iPods and Chevy Volts? Yeah, I thought so...
So, Krugman, you're right. If we don't care about poor people (or anybody but the very rich), we should absolutely mimic the Fed and focus only on core inflation. How a self-described "liberal" can espouse a policy that so clearly favors the richest of the rich is absolutely baffling to me.
Here's my full e-mail response, if you're interested to learn more about biflation and why I don't trust the Fed or quantitative easing.
What worries me most (and what I think these Fed policies are likely to cause) is "biflation"--where the costs of vital goods (food, energy, clothing) increase fairly rapidly, while deflation persists elsewhere (technology--where it's considered perfectly normal, autos, housing, other durable goods). Essentially, earnings-based assets (commodities) increase in price, while debt-based assets decrease. This is already occurring in the markets, where commodities prices are shooting through the roof, while "core inflation" measures--which include durable goods--have remained stagnant (low levels of "core inflation" are a large part of Bernanke's justification for his policies).
Biflation creates a particularly dangerous situation because it severely harms the poor, while not promoting their employment. Recall that the poorest 20% of Americans spend roughly 60% of their income on food and energy, whereas that proportion for the richest 20% is closer to 10%.
Furthermore, the increase in the cost of staple goods will cause margin pressure on almost all corporations as their input costs rise, which will put pressure on profits and make them reticent to begin hiring. Biflation is particularly dangerous when you consider that nearly all of our most important businesses in America are in the provision of durable goods rather than vital goods (exceptions include ExxonMobil, Chevron, etc., but it's clear to see how biflation would hurt banks, technology companies, and not least of all Wal-Mart, our nation's largest employer by a long shot).
Bernanke has claimed that his policies will create a "wealth effect" as stock prices rise--the wealthy will spend their new money on all sorts of goods, creating traditional trickle-down economic growth. I'm skeptical. I think that few investors are comfortable that stock prices will remain at their current levels, and they won't begin spending that "wealth" until they are comfortable that it's here to stay. The longer they do not, the more time higher input costs will have to flow through to corporate earnings. As earnings decrease, so too will stock prices, possibly creating a self-fulfilling prophecy for investors--as stock prices correct, they'll have even less reason to spend their newfound wealth.
It's not a rosy picture, but I think it's fairly clear what overly aggressive Fed policies have created in the past. Asset bubbles are essentially unsustainable, and incredibly ugly when they burst. The Fed has determined that the best way to save the economy is to create a new asset bubble. I think that's foolhardy. Our economy has significant structural problems that will take time to work out--I'd take a Japanese-style lost decade any day if my other option is a decade of relentless bubble-blowing and bursting. I especially feel that way since we've already essentially HAD a lost decade--since 2001, we've seen an increase in unemployment and national debt, a decrease in the dollar's purchasing power, and no increase in the stock market (in fact, the S&P is about 8% lower than it was in Jan. 2001). That's what these Fed policies do.
We need to be patient and work the bad debt out of the system, not panic and flood the market with easy money so as to encourage more risky debt-fueled behavior.
[New York Times]
[Wall Street Journal]
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