There’s an old saying, which I’ve seen attributed to every from Daniel Patrick Moynihan, to the effect that while a man is entitled to his own opinion he is not entitled to his own facts. This saying would seem to be particularly relevant to current arguments about the Federal Reserve and monetary stimulus. As I noted in my last post, some commentators have been warning for years that the Fed’s actions would cause a return to the high inflation of the 1970s, if not to 1920s Germany. Yet more than two years on, this inflation has failed to materialize.
This fact should be embarrassing to those who made the warnings. Instead of dealing with the implications of their failed predictions, however, some have chosen to simply deny reality and claim not only that high inflation is inevitable but that it is already here, and that it’s invisibility is due to manipulation or inadequacies in the inflation figures.
Food and Energy
For example, I’ve lost count of how many times I’ve heard someone make the argument that you can’t trust the CPI inflation numbers because they don’t include food and energy prices. Whenever I cite the below target CPI numbers as evidence that we need more monetary stimulus, someone is certain to respond that the CPI is bogus because it doesn’t include food or fuel in its calculations.
This, however, is completely false. The CPI includes food and energy prices. At the risk of repeating myself, allow me to repeat myself. The CPI includes food and energy prices. Look at the blue line in the above chart. That’s the CPI with food and energy prices included. It shows deflation in 2009, and an inflation rate of about 1.2% today.
The government does also calculate a separate “core” inflation number, which excludes food and energy prices (on the grounds that such prices tend to be pretty volatile, and so can skew the overall number). That is represented in the above chart by the red line. Notice that the red line is higher than the blue line throughout most of 2009. Indeed, the regular CPI shows deflation for most of 2009, whereas the core inflation number is small but still positive. What that means is that food and fuel prices (taken in the aggregate) were actually going not up but down.
It takes a certain amount of chutzpah to say that the CPI is hiding inflation because it doesn’t include food and fuel prices when 1) the CPI does include food and fuel prices, and 2) taking out food and fuel would actually make the inflation rate seem higher.
Because the CPI numbers are so unhelpful to proving the existence of inflation, it is perhaps not surprising that some inflation hawks reject the CPI altogether in favor of their own inflation calculations which, again no big surprise, show much higher inflation. Now of course it is always good to take government figures with a grain of salt. But when a group dedicated to proving X comes up with its own alternate figures which show X, this also calls for a salting.
Generally speaking, the inflation numbers provided by places like ShadowSats or the National Inflation Association (which uses ShadowSats numbers) do not stand up to scrutiny. According to the NIA, for example, “the median household income in 1975 of $11,800 actually equals $154,000 in today’s dollars.” That’s not even close to being plausible.
There are a number of private groups working on their own price indexes who do not seem to have much of an agenda in making the numbers come out a certain way. Google, for example, is working on a price index which would be comprehensive of all prices listed on the internet. While Google isn’t publishing its index yet, officials at Google have said that “the GPI shows a ‘very clear deflationary trend’ for web-traded goods in the US since Christmas.”
Some commentators have also tried to prove the existence of high inflation by cherry-picking data on commodity prices. As I alluded to before, commodity prices tend to be relatively volatile, with big price swings up and down.
As you can see from this chart, commodity prices took a big plunge in 2009, declining almost 60%. In 2010 prices bounced back somewhat, though the level of increase is not atypical and has not offset the decrease from 2009. If you only look at the period since commodity prices hit bottom, however, you can make it look as if we are undergoing some unprecedented price spike, which is no doubt merely the first sign of a soon to be general hyperinflation.
And then there is gold. Gold prices have increased substantially over the last three years, and some see this as a sign of either impending inflation or of inflation that is already here. As Scott Sumner notes, however, using gold as a forecast of U.S. inflation, however, is problematic for two reasons.
1. Gold prices are set on a world market, so an increase in the price of gold could be due to inflation expectations in other parts of the world, rather than in the United States.
2. Gold prices are not simply a reflection of inflation expectations, as gold is used for lots of other things besides a store of value. An increase in demand for gold jewelry, for example, or in the use of gold for industrial purposes, would tend to raise the price of gold just as well as concerns about possible inflation.
So you can’t just assume that an increase in the price of gold means lots of inflation for America. From the little I’ve looked into it, it appears that the rise in gold is due mainly to increased demand in China, rather than to Fed policy. And given that all the other indicators show very low inflation in the U.S., I see no reason not to accept this as an explanation.
What about the future?
Okay, you might say, I’ll concede that the U.S. isn’t experiencing high inflation right now. But how do we know that hyperinflation isn’t just around the corner? And the truth is that, as Yogi Bera once said, you have to be careful about making predictions, especially about the future. However, all of the indicators that we have suggest that high inflation is not likely to occur any time soon.
There are a number of ways of forecasting what the future inflation rate is likely to be that go beyond simply relying on one’s gut. For example, for the past few years the government has offered inflation protected securities in addition to its regular bonds. Whereas normal treasury bonds pay a set nominal interest rate, these bonds (called TIPS for treasury inflation protected securities), pay a set nominal rate plus inflation. By looking at the difference in interest rate between TIPS and regular treasuries (called the TIPS spread) we can get a market forecast of what the expected inflation rate will be over the given time period.
You can also buy CPI futures contracts directly. Just as oil or pork futures involve a bet on what the price of oil or pork will be at a given future date, so you can buy a CPI futures contract based on what inflation will be some time in the future. The CPI futures market thus can be used to see how much inflation the market is forecasting.
Both the TIPS spread and the CPI futures market show low expected inflation for the foreseeable future. If you believe that markets are good at setting prices correctly, then you should believe that these forecasts are a fairly good indication that high inflation is not just around the corner. And if markets don’t do a good job of setting prices, then I would submit the Austrian school of economics (which is behind a lot of the inflationary fears) has bigger problems.