The Atlanta Fed's macroblog provides commentary and analysis on economic topics including monetary policy, macroeconomic developments, inflation, labor economics, and financial issues.

Authors for macroblog are Dave Altig, John Robertson, and other Atlanta Fed economists and researchers.

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August 31, 2006

Still Not As Good As It Looks

Once again, I find myself not so convinced by what at first appears to be good news on the inflation front.  From Reuters:

In another sign of moderating inflation, the government reported earlier Thursday a smaller-than-expected 0.1 percent July rise in the core personal consumption expenditure index, the Federal Reserve's preferred inflation gauge. The core PCE advanced 0.2 percent in June.

That core personal consumption expenditure index, of course, is the PCE exlcuding food and energy components.  But the Dallas Fed provides an alternative look, that is not so wonderful:

The trimmed mean PCE inflation rate for July was an annualized 3.1 percent. According to the BEA, the overall PCE inflation rate for July was 4.1 percent, annualized, while the inflation rate for PCE excluding food and energy was 1.7 percent.

That 3.1 percent represents a slight increase over the 3.0 percent annualized increase in June.  I can really do no better than repeat what I said in my post about about the Consumer Price Index inflation report a few weeks ago:  Unlike the traditional core inflation measure, which simply excludes food and energy components, the trimmed-mean measures excludes both high and low price changes, no matter what they might be.  The idea is to get a picture that is not distorted by items with prices that are increasing by a lot, or decreasing by a lot.  And that picture just isn't improving that much:




Almost 60 percent of expenditure-weighted price increases -- 59.16 percent to be exact -- were over 3 percent annualized in July.  That is a slight deterioration relative to the year for a whole -- the corresponding figure for the first 7 months of 2006 is about 52 percent -- but, more importantly, the shift in the distribution is clearly toward higher rates of increase.

I'm not surrendering, but it is clearly too early to declare victory on the basis of a good PCE ex food and energy signal, even adjusting for the usual caveat to not get overly exxcited about one month's data.

August 31, 2006 in Inflation | Permalink


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I’m not sure I understand the rationale for the trimmed mean. In principle, you want to exclude prices that are unlikely to exhibit persistent rates of change. There is a good case for excluding energy because energy is storable, and with nominal interest rates still relatively low, there would be a large incentive to “buy now and sell later” if (recent large positive) rates of energy price increase were expected to be persistent. Note that this argument applies whether or not energy is at the extreme of the distribution. Except for discrete changes when new information arrives, energy prices should be expected to rise slowly no matter what the rest of the distribution looks like, provided that nominal interest rates and storage costs remain relatively low (and provided that substantial inventories exist; otherwise you could have expected declining prices). The case for food is a bit weaker, since storability is limited, but it has been observed that food prices are volatile. Similar arguments do not automatically apply to things found at the extremes of the price change distribution. For example, prices of certain computer components have been consistently near the bottom of the distribution because they benefit disproportionately from technological progress. That will most likely continue to be the case. It is not reasonable to exclude such things just because they are at the extremes of the distribution.

Posted by: knzn | August 31, 2006 at 04:44 PM

As the right side non-discretionary spending rises, the left side discretionary spending falls putting a hard ceiling on prices. The larger the right gets, the less there is remaining to spend on the left side.

Nice graphic - a picture really is worth 1k words.

Posted by: RP | September 01, 2006 at 06:23 AM

knzn -- The idea is similar to the idea of the ex food and energy measure: To filter out the high frequency noise to get a truer picture of the underlying trend in the inflation series. Rather than arbitrarily excluding a couple of components that may or may not be distorting the picture in a given month, trimmed-mean estimates are agnostic about what to exclude -- anything that experiences a particularly volatile price change in a given month gets knocked out. The Dallas Fed uses a technique that chooses the optimal amount to trim off the high and low tails of the distribution -- where optimal is defined as coming up with measure that tracks the true underlying inflation trend as closely as possible.

The Dallas Fed has a very nice, and very accessible description of the trimmed mean here:

There are also links to more technical information.

Posted by: Dave Altig | September 01, 2006 at 07:21 AM

uncertain contends comparable efforts

Posted by: mayblack | April 01, 2009 at 04:49 PM

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August 30, 2006


There is a little something for everyone -- that is to say, things to cheer about, things to frown about -- in the Census Bureau's report on Income, Poverty, and Health Insurance Coverage for 2005.  MarketWatch summarizes:

Real U.S. median household income rose 1.1% in 2005, climbing for the first increase since 1999, but inflation-adjusted incomes still have not recovered fully from the 2001 recession, the Census Bureau reported Tuesday.

Real median incomes for 2005 rose 1.1% to $46,326 but were down 0.5% from 2001's $46,569. Median income means half of the 114.4 million U.S. households earned less, half earned more. The figures have been adjusted for inflation.

Income inequality continued to increase, with the top 20% of families accounting for a record 50.4% of all household income, just the third time since the mid-1960s that they've taken more than half. For the top 20%, the median income rose by $3,592, or 2.2%, to $166,000.

Meanwhile, the bottom 20% captured just 3.4% of income, matching their lowest share since the mid-1960s. Median incomes for the bottom 20% increased by $17, or 0.2%, to $11,288...

The poverty rate declined for the first time since 2000, nosing down to 12.6% from 12.7%, but this amounted to a statistically insignificant change, the government said. The poverty rate was 1.3 percentage points higher than 2001's 11.3% but was lower than the 13.8% average in the 1990s.

A couple of things I found interesting in details.  A few facts: About 27 percent of people 25 years of age or older had incomes less than twice the poverty level.  For prime working-age folks -- those between 25 and 65 -- with at least 4 years of college, your chance of having income that low was, in 2005, between 8 and 12 percent (depending on your exact age group).  Among those with high-school degrees only, the chance of being in the low income group ranged from 25 to 39 percent.  And without a high-school degree?  Your chance of having an income less than twice the poverty rate was in excess of 50 percent.
When thinking about income inequality -- especially among those away from the extremely high and extremely low levels of income -- there is just no escaping this picture:


The second thing I found interesting was the reasons that people who were not employed gave for not working:
Conclusion?  If you are poor and not working -- which is the most common circumstance for those under the poverty line -- the reasons are not obviously related to the state of the labor market.
UPDATE: The comment by kharris below made me realize that that last sentence is pretty silly. It is clear that choosing retirement rather than work, work at home rather than work in the market, and choosing educational investment over employment are inherently related to conditions in the labor market.  I was thinking in terms of conditions related to unemployment, and so the phrase probably should have read:
If you are poor and not working -- which is the most common circumstance for those under the poverty line -- the reasons are not obviously associated with a lack of jobs for those who choose to remain in the labor force.
Stated that way, it is clear that judging this to be a good or bad thing is pretty tricky.  Those who are retired or have decided to stay home to attend to family may simply be discouraged by the lack of opportunity.  And we might lament that the return to working is so low that poverty is associated with separation from the labor force.  On the other hand, we might be encouraged that such a large fraction of those under the poverty line appear to be making a deliberate choice to acauire human capital.  This is one of those cases where each of theose reactions is probably justified.
BLOGLAND UPDATE: Mark Thoma has an extensive round-up, the dominant theme being that this is a bad report.  Daniel Gross is not so impressed either.  John Irons declares the increase in the number of Americans without health insurance "bleak." 

August 30, 2006 in Health Care, Inequality, Labor Markets, This, That, and the Other | Permalink


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» Are Conditions Getting Worse for the Poor in the U.S.? from EclectEcon
There has been quite a bit of discussion in the media and around the blogosphere during the past couple of days about labour income and about conditions for the U.S. poor. Here's more from ... [Read More]

Tracked on Aug 30, 2006 1:57:02 PM


See Thoma,
for all the bad news. Entry college graduate salaries continue to fall. Rising incomes are only among immigrants and the elderly

Posted by: Lord | August 30, 2006 at 02:33 AM

"If you are poor and not working -- which is the most common circumstance for those under the poverty line -- the reasons are not obviously related to the state of the labor market."

Huh? We have no way of knowing how the people below the poverty line are distributed across categories in the reasons-for-not-working pie charts. One could just as easily assert, based on the pie charts, that reasons for poverty are not obviously unrelated to the state of the labor market.

Posted by: kharris | August 30, 2006 at 03:46 PM

kharris -- The pie chart applies only to people below the pverty line, so I'm not entirely sure what you mean. However, see my comment above, because there is a sense in which my statement was poorly crafted.

Posted by: Dave Altig | August 30, 2006 at 09:26 PM

Globalization will continue to keep a lid on wage inflation here in the US... JMHO.

Posted by: muckdog | September 02, 2006 at 02:21 AM

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August 29, 2006

More Confusion About The Return To Labor

Regular readers of macroblog know that one of my pet peeves is the insistence of some to measure labor compensation using narrow measures of hourly wages.  Yesterday, The New York Times continued to insist in an article titled "Real Wages Fail to Match a Rise in Productivity." 

Not to fret, though.  Russell Roberts administers the smackdown:

Let me repeat the key sentence:

The median hourly wage for American workers has declined 2 percent since 2003, after factoring in inflation.

That's a very strange sentence for many reasons:

1. Why would you use a measure of compensation that ignores benefits, an increasingly important form of compensation?

2. Why would you use 2003 as your starting point when the recession ended in November of 2001?

... for every year since the recession of 2001, real hourly compensation has actually increased. It's up since 2003 as well. And this year it's up quite dramatically...

As I have mentioned here before--the standard claims you hear about labor's share declining come from using wages without other forms of compensation. When you include benefits, labor's share is virtually a constant at 70% of national income and has been steady since the end of World War II,

I might just stop there, but on this topic I really can't stop complaining. In reading the Times piece, The Capital Spectator instead focuses on what would appear to be the flip side of the claim that labor share is falling: A rising share of income accruing to capital.  Again from the Times article:

In another recent report on the boom in profits, economists at Goldman Sachs wrote, “The most important contributor to higher profit margins over the past five years has been a decline in labor’s share of national income.”

I'm not sure how that conclusion is reached, but my colleagues Paul Gomme and Peter Rupert make this observation:

.. for labor’s share as computed by the Bureau of Labor Statistics, a fall in labor’s share does not necessarily imply a rise in capital’s share; indirect taxes and subsidies constitute a wedge between these two series. Consequently, a fall in labor’s share could be associated with a rise in capital’s share, but it could also be due to a rise in the share of indirect taxes less subsidies... Further, the terms “capital’s share” and “profit share” are often used interchangeably, ignoring the fact that capital income derives from more sources than just (corporate) profits.

What I think is more important in the Gomme-Rupert analysis is this, from one of my previous discussions on this topic:

... the “historic lows” in labor’s share are observed only in the nonfarm business sector series produced by the Bureau of Labor Statistics. Other measures of labor’s share—for example, for the nonfinancial corporate business sector or the macroeconomy more broadly—are currently near their averages over the last several decades.

Those alternative measures are ones that avoid, for example, the problems associated with allocating rental income and proprietor's income between labor and capital.  (In other words, they avoid imputing things that we don't observe.)

In what I suppose is a related topic, there has been plenty of blogging in the last several days on the injunction against a strike by Northwest Airlines flight attendants, union-busting, and wage inequality -- from Dean Baker, from Brad DeLong, and from Mark Thoma (among others, no doubt). 

Just about a month ago the raging debate was about why it might be that changes in income inequality have been concentrated among the top 1% of income earners -- excellent examples of that debate being found here and here. Once you have identified the real issue as being about the top 1% of the income distribution, I'd think you have pretty much ruled out unionization (or the lack of it) as a dominant driver of the major trends in who gets what.  In any event, on the question of unionization and wage inequality, I'm with Greg Mankiw.

UPDATE: Max Sawicky takes me to task for omitting this from the Gomme-Rupert quotation above:

... we find that the share of indirect taxes less subsidies does not vary much.."

Well, it certainly wasn't my intention to deceive, but Max has a good point. I'll consider my knuckles duly rapped.

In a related vein, Dean Baker notes that depreciation can also cloud the picture on capital sharel.  knzn thanks Dr. Baker for us all, but comes to the "indirect taxes" conclusion: There's not enough action there to eliminate the decline in standard labor share calculations.

Greg Mankiw covers the theory of productivity and wages, and provides several reasons the data might not cooperate with theory (including Dean Baker's observations that different price indexes are in play).  If you would like to see the math behind Professor Mankiw's discussion of labor shares and the Cobb Douglas production function, Economic Investigations has just what you're looking for.

If that's not enough, there's more at The Big Picture and at ElectEcon.

August 29, 2006 in Labor Markets | Permalink


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I wouldn't want to spoil the party, but I do not see the problem of inequality as being a top 1% problem. In fact, I would say that at least the top 5%, and perhaps the top 10% have gotten more than their share of productivity gains over the last quarter century.

According to the State of Working America, the real wage for workers at the 90th percentile rose by 27.2 percent from 1979 to 2003. Wages for workers at the 95th percentile rose by 31.1 percent.

As you rightly note, there has been a shift to non-wage compensation over this period. This shift was almost certainly strongest among those in the top wage brackets (the tax code gives high-wage earners more incentive to get compensation in tax exempt or deferred non-wage forms). We also know that high-wage earners are far more likely to have health care and pension coverage than low-wage earners.

For these reasons, it reasonable to believe that the compensation of workers in these income brackets did increase more than average productivity growth over the last quarter century. While these folks may not have pockets nearly as much as the CEOs and Wall Street honchos, they are nonetheless accomplices in the great upward redistribution of the period, and can be counted on to provide an important political base to the new status quo.

Posted by: Dean Baker | August 29, 2006 at 10:36 AM

Dave, What's your point, that leftys are not without blame when it comes to slanting economic argument? It's the arguer's preogative what he includes & within that, what he emphasizes. It's tough for me to find fault with this irksome peeve of yours because, as you are sufferingly aware, I think adoption of the Boskin Commission recommendations was inappropriately frontrun by AG, was illconsidered, & has been disastrous for our economy. (By the way, Dean Baker was one of VERY few Economists who questioned the wisdom of the changes).

Posted by: bailey | August 29, 2006 at 04:39 PM

OK, real compensation is up a little. Real GDP per capita growth appears to exceed real compensation. Put another way - if labor productivity growth exceeds real compensation growth, how can it not be that the profit share has not increased? As I said over at Max Sawicky's place (he's touting this year's upcoming release of EPI's "big book") - are we talking about the same economy?

Posted by: pgl | August 29, 2006 at 06:37 PM

"Consequently, a fall in labor’s share could be associated with a rise in capital’s share, but it could also be due to a rise in the share of indirect taxes less subsidies..."

talk about slanting the debate - the part you misssed, deliberately obfuscated by the ellipsis - surprise, surprise -

.. we find that the share of share of indirect taxes less subsidies does not vary much..

You are just a plain liar

Posted by: comeon | August 29, 2006 at 09:22 PM

Dean -- I agree.

bailey -- I'm not accusing the Times of being either lefty or of slanting things. I just think that the use to which they are putting the wage measure -- for making some statement about the overall return to labor -- is inappropriate. I've probably said it enough, and should stop, but geez, people just keep tempting me.

pgl -- Although it is probably not clear, I don't really feel like I have a stake in whether labor share is historically low or not (other than a bounce back might have some consequences for short-run inflation dynamics and I would dearly love to keep using Cobb Douglas production functions). I'm just not sure that the labor share data is reliable, for the reasons articulated by Gomme and Rupert. But as you point out (differences between profits and total returns to capital -- which includes returns to lenders -- aside) this does mean I am also suspicious of productivity numbers.

comeon -- I suspect that you posted your comment prior to my mea culpa. I do find it distressing that you see fit to call me a liar. I try very hard to be forthright in my writing here, to promote a culture of civility, and keep an open mind about things. I fear that it says something about the nature of much debate in the blogoshpere that your immediate assumption was that I was dissembling, and not that I simply made an honest mistake.

Posted by: Dave Altig | August 30, 2006 at 09:20 PM


I also get annoyed when people focus on a narrow measure of compensation ... when a broad one is available.

But, if you want to talk about distribution, or even just medians like in the NYT article, there isn't a broader measure of compensation that you can turn to. Since non-wage payments are a significant share of total compensation, this is a significant hole in U.S. economic statistics. So in this instance, you should probably direct your annoyance to the BLS rather than the NYT.

BTW, the best evidence that I know of on true ineqaulity of compensation is (BLS economist) Brooks Pierce's paper that was in the QJE a few years ago. Using the data underlying the ECI, he was able to construct reasonable measures of total compensation at the micro level. His conclusions support what Dean Baker said above: (1) Data on wages and salaries significantly understate the degree of inequality. I.e., the upper end of the distribution gets a bigger share of the benefits than they do of the wages. (2) The wage and salary data understate the magnitude of the increase in inequality that occurred in the 80s and 90s.

Posted by: Dan Sullivan | August 31, 2006 at 12:01 AM

Dan -- Thanks a bunch for those comments. I wasn't aware of the Pierce paper (though I should have been -- Sounds like a blog opportunity!) As my response above indicates, I agree with Dean's comments. I hope that none of my own comments are construed as an attempt to deny the fact inequality has risen -- no sensible person would do so. My beef with the nyt article was its insistence on attempting to correlate wages ex benefits etc. with productivity, labor share and so on. That even though the authors seem to know better, as evidenced by their notice of broader compensation numbers. I'm not even claiming that their general conclusion is wrong -- as I said above, I have no horse in that race beyond wanting to understand the facts. I just dearly wish folks who claim to inform would focus on measures that are meaningful for the question at hand.

Posted by: Dave Altig | August 31, 2006 at 08:39 AM

"I just dearly wish folks who claim to inform would focus on measures that are meaningful for the question at hand."
BRAVO, Put it on the masthead!

Posted by: bailey | August 31, 2006 at 10:12 AM

Income inequality is such a loaded term. Is the claim that those who saw a higher rise in real income did not produce an equivalent rise in productivity?

If workers on the lower end of the pay scale produce less of an increase in returns for their labor, why shouldn't their compensation increase at a lower rate than those whose labor produces returns which have grown more substantially?

Posted by: stan | August 31, 2006 at 11:31 AM

Dave -- Your welcome. I think the Pierce paper is an important one that should be better known.

BTW, if what Russell Roberts administered was a smackdown, David Leonhardt just delivered a pretty effective smackback.

Posted by: Dan Sullivan | August 31, 2006 at 11:15 PM

Good analysis. I've had th is on my mind lately, but I don't draw a lot of comments so dealing with the issue hasn't been a priority to me. I've been trying to avoid posting formal terms of service in the standard legalese because it evokes an atmosphere I'd like to avoid. But I will revise my templates and terms today to make matters a little more clear.

Posted by: blogsolution | February 11, 2009 at 06:52 PM

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August 28, 2006

Crabbing About Core

The Bank of England's Charles Bean had some negative things to say about core inflation at this year's edition of the Kansas City Fed's annual Jackson Hole thinkfest -- comments duly noted by Daniel Gross, by Mark Thoma, and by Michael Kowlaski -- but he was not the only one taking potshots at the core concept this weekend.  William Safire -- the New York Times' wordsmithing maven -- had some complaints of his own:   

The man whose words are parsed more closely than anybody else’s in the world opined in early June to a bunch of bankers that this year’s “core inflation” — setting aside volatile food and gas prices — “has reached a level that, if sustained, would be at or above the upper end of the range that many economists, including myself, would consider consistent with price stability.”

So said Ben Bernanke, current chairman of the Federal Reserve, in a written sentence that he must have sweated over for a week. I think his point was that inflation may be getting too high (in which case it would be inconsistent with price stability), and so I ran his words past Floyd Norris of The Times, a practiced Fedspeak cryptologist. “What bugged me most about the sentence is its reliance on ‘core’ inflation,” noted my colleague. “Using the core figure for very short periods of a few months may make sense as a way to avoid meaningless volatility, but using it for six months or even longer is hard to understand.”

Even harder to understand is why economists have picked up a vogue word in politics — every “power base” now boasts a “core constituency” — and are using it to modify “inflation.” It is a word with beautiful poetic associations, from Shakespeare’s “I will wear him in my heart’s core, ay, in my heart of heart” to Keats’s “A virgin purest lipp’d, yet in the lore/Of love deep learned to the red heart’s core.” Now here it is qualifying the rising cost of living. “The ‘core inflation’ rate,” Norris says, “is relevant for those who neither eat nor use energy.”

I don't know about that poetry stuff, but in conflating "core" with "cost of living", I think Mr. Safire gets exactly the wrong idea.  My colleague Mike Bryan explains it this way:

In theory, cost-of-living changes are measured by envisioning the cost of attaining a certain level of welfare and comparing that cost in different places or different periods of time. Unfortunately, “welfare” is impossible to quantify and a more practical approach is to calculate the cost of a representative market basket of goods and services and compare that cost between two places (like Cleveland and New York) or two periods of time (like 1960 and today)...

Many of the problems identified with the CPI (and other similar market basket approaches) have been well known to economists for nearly a century. Most arise because the basket of goods and services used to compute the cost-of-living statistic gradually becomes dissimilar to the basket of goods and services actually purchased by consumers... But another problem is that market basket statistics also pick up inflation because they measure the money cost of the basket. That is, the CPI can rise even if the cost of living is constant if the Federal Reserve continues to oversupply money and makes the dollar an increasingly inflated measure of cost.

Price statistics that attempt to isolate the persistent rise in the general price level are commonly called core (or underlying) inflation statistics...

An alternative procedure for measuring core inflation is to reconstruct the market basket in a way that reduces the influence of transitory price fluctuations originating in various components of the index. The idea here is that although such price swings may reflect changes in the cost of living, they are not part of a persistent rise in the general price level that comes from a monetary source. The best-known core inflation statistic excludes food and energy goods from the consumer market basket...

... By excluding some components of the market basket, the measure no longer reflects consumer spending patterns and therefore fails to qualify, in a meaningful sense, as a cost-of-living statistic; volatile or not, food and energy are important to our cost of living.

But it may be a useful signal of the underlying rate of change in the purchasing power of money, which -- speaking for myself -- seems like just the right idea.

UPDATE: Greg Mankiw opines:

This is yet another reason to think that for the foreseeable future the Bernanke Fed's commitment to inflation targeting is likely to be vague and informal. Monetary policy will remain more discretionary than rule-based.

August 28, 2006 in Federal Reserve and Monetary Policy, Inflation | Permalink


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The Fed should focus exclusively on a combination of commodity and asset price inflation. By the time iflation is picked up by the core rate, bubbles and rampant speculation have already inflicted severe and destructive disequilibria in the economy. The current mess created by Greenspan is the best example. The crash of the Japanese asset bubble is another. The 70's inflation was another.

I cannot think of one inflationary binge that wasn't led by a speculative surge in commodities prices followed by a bubble in equities or housing or both. The Fed is the cause of this one and failed to respond until it was too late.

The core rate is an insensitive lagging indicator that promotes speculation, market manipulation, bubbles, and inflation.

Posted by: blam | August 28, 2006 at 10:33 PM

I really don't understand people like Floyd Norris who think that the Fed should worry about the price of oil and food. Oil prices have risen because of rising global demand, not because the Fed is printing money.

Does Mr. Norris think that the Fed should _raise_ interest rates in order order to reduce inflation? That would surely bring on a 1980-style recession.

The Fed is letting inflation run high in order to "grease the wheels" of this relative prices shift, no?

Posted by: Andy | August 29, 2006 at 10:24 AM

Is quantifying welfare MORE impossible than eliminating the subjective decision-making integral to our market-basket methodology?
The problem is we've micro-massaged the process until it's lost all relevance. I accept K. Abraham's input to the Boskin Hearings: it could also be argued that cpi was underrepresented by a full point. (That would place cpi a full 2 points higher than where it is today!)
Personally, I'd welcome ANY inflation measurement that would correlate to a representative population sampling.

Posted by: bailey | August 29, 2006 at 11:05 AM

«In theory, cost-of-living changes are measured by envisioning the cost of attaining a certain level of welfare and comparing that cost in different places or different periods of time.»

That's complete bullshit. Perhaps in the theory used by prevaricators and dissemblers.

The CPI is called the Consumer Price Index for a good reason, not the Consumer Welfare Index.

And it is used to do Cost Of Living Adjustments whose purpose is not to maintain the ''welfare'' of low and middle income families, but their relative purchasing power.

The distinction is very important, because otherwise prevaricators and dissemblers have free reign with disingenuous techniques like hedonic adjustments.

Consider the case of a car: you can purchase today a much better car than in 1985, for a somewhat higher price. Does this mean that, as it would be in ''welfare'' terms, car price inflation has been negative? Not at all: because you cannot purchase today a new 1985 car for smaller price than in 1985. What you can purchase is a much better car of the same class for a higher price, so there has been car price inflation.

And that the CPI used for COLAS is means to measure relative purchasing power is the right thing. Overall the purpose of COLAs is to prevent price feedback loops; because without COLAs various categories would negotiate higher salaries to compensate for perceived falls in their relative standard of living, and if everybody tries to beat inflation, then inflation can only go up (leapfrogging).

Thus purpose of COLAs, and the CPI on which they are based, is to prevent leapfrogging, not to preserve an absolute standard of welfare.

Naturally governments routinely try to trick that by ensuring that the CPI used for COLAs greatly understates rises in purchasing power, and one of the tricks used is to argue that it should really measure an absolute standard of welfare, not a relative one of purchasing power.

Posted by: Blissex | September 02, 2006 at 11:13 AM

«I cannot think of one inflationary binge that wasn't led by a speculative surge in commodities prices followed by a bubble in equities or housing or both. The Fed is the cause of this one and failed to respond until it was too late. The core rate is an insensitive lagging indicator that promotes speculation, market manipulation, bubbles, and inflation.»

Ok, and what makes you think that the *purpose* of using the core is not promoting all that stuff?

The USA have an expensive war or two running that are being financed without taxes, and there is a huge overhang of debt both in the public sector and in large segments of the private sector.

One can fix these problems either with a painful recession or with a smooth rise in inflation, while talking cautious.

Posted by: Blissex | September 02, 2006 at 11:18 AM

«Personally, I'd welcome ANY inflation measurement that would correlate to a representative population sampling.»

But that is exactly the purpose of the CPI used for COLAs! To measure the purchasing power of a representative family of wage earners (not of the whole population), so they don't have to strike merely to maintain their purchasing power, which can easily degenerate into leapfrogging.

The theory is/was that if all prices, including labor prices, are indexed to preserve purchasing powers, then it is much easier to achieve a soft landing.

And that the CPI used for COLAs has this purpose is why it has to be relative to a specific time and place and category of workers.

There is actually a rationale to exclude short term food and energy movements from the CPI used for COLAs: and it is that while food and energy prices in the short term can do down, bringing potentially down the whole CPI, COLAs can't be negative.

So the problem is not the volatility in general of food and energy prices, but that such volatility extends into negative values.

But this is an argument for adding to the CPI smoothed food/energy prices, not for ignoring them.

Posted by: Blissex | September 02, 2006 at 11:27 AM

«ensuring that the CPI used for COLAs greatly understates rises in purchasing power»

Oops, here I meant to say: ''greatly understates FALLS in purchasing power''.

Posted by: Blissex | September 02, 2006 at 06:12 PM

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August 26, 2006

A Laffer Critic With Critcism I Criticize

At (hat tip, The Capital Speculator), Arthur Laffer comes under fire from fellow traveler Bret Swanson for his defense-of-the-Fed opinion piece in Thursday's Wall Street Journal.  I'm not one to dive into family disputes, but there is at least one contention to which I feel a response is needed.  Swanson writes:

-- Dr. Laffer says expected inflation gleaned from TIPS bonds is the best predictor of inflation, but in fact TIPS have not been very good at all at predicting inflation.

I don't think there is any way to draw that conclusion.  When monetary policymakers think about inflation expectations, the focus is almost always on long-term expectations -- the assumption being that the central bank has only modest control over inflation on a year-to-year basis. Since Treasury Inflation Protected Securities were introduced in 1997, it is just not possible to determine whether they have been good predictors at the relevant 5 to 10 year horizon.

Of course, the argument works both ways.  Though I tend to agree with the sentiments expressed by Ryan DeJarnette (thanks again, TCS)...

Mr. Laffer explains inflation is under control when looking at the TIPS spread, or the difference in yields on TIPS and the 10-year bond. This spread tells you the market, which is the most efficient and effective entity when it comes to valuation and prediction, expects 10 year inflation rates around 2.5% a year...

... the claim that the TIPS market is giving us the "the most efficient and effective" estimate of inflation expectations, and hence inflation, is still largely an article of faith.  Though there are several reasons that the simple TIPS spread might not be an unbiased predictor of inflation -- because of differentials in liquidity, for example -- trusting in this market measure of expectations is a leap I'm willing to take.


August 26, 2006 in Inflation | Permalink


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Just an argument against Tips.

While using tips shows no recent decline in real bond yields other measures of inflation and inflation expectations do show a drop in real bond yields. But we are also starting to see monetary velocity for botn M2 and zero maturity money rise and that is what you should expect to see when real yields drop significantly below 4%.

A form of indirect evidence that the tips inflation estimate may not be accurate.

Posted by: spencer | August 27, 2006 at 04:31 PM

The measure could potentially have lots of distortions. But seems to be getting better as time goes by and the outstanding increases... See the link for a study on Canadian data.

Posted by: Frederic Dion | August 27, 2006 at 06:23 PM

TIPS track CPI expectations, not inflation expecations.

Posted by: Matt | August 28, 2006 at 03:50 PM

I'd say that the TIPS spread is an unbiased predictor of future inflation in much the same way that long-term interest rates are unbiased predictors of future short-term interest rates. Both represent the market's best estimate at a given point in time. However, both inflation and short-term interest rates are impacted by so many factors that its unlikely anything is going to be a particularly good predictor of the future.

Posted by: Tom Graff | August 28, 2006 at 05:47 PM

Matt -- fair enough.

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August 25, 2006

Is It Just Me?

Yesterday I contemplated this week's news from the U.S. housing market, and concluded with this:

There is plenty of cause for concern, and plenty of uncertainty about the outlook.  But to me it seems just a bit premature to be pushing the panic button.

The early reviews from readers go something like this: The housing market is in the tank, and you, Mr. Dave, are either a knucklehead or afraid to tell the people the straight facts.

First, let me note that I did say this:

... rising inventories of unsold homes -- Barry Ritholtz has the pic -- seems unlikely to be a harbinger of a rally just 'round the corner.  And I might join The Capital Spectator in concluding that "the pullback in housing is something more than a minor hiccup." 

To put it straight, I harbor no illusions about the state of the residential housing market.  But I am a macroeconomist -- and one primarily engaged in thinking about national economic monetary and fiscal policies at that -- so my tendency is to focus on the trajectory of the entire economy.  In the best of times there are some sectors of the economy that struggle, and it is not clear that these are the appropriate objects of policy. 

More to the point, softening in housing markets, and attendant consequences on consumer spending and GDP growth, are already embedded in every reasonable forecast.  They also include the expectation that the future will in part bring a rising share of business investment along with a falling share of household consumption.  So an important part of the news yesterday came in the form of the July durable goods report.  From Reuters:

New orders for U.S.-made durable goods fell a much greater-than-expected 2.4 percent in July as civilian aircraft and car orders tumbled, the Commerce Department reported.

But non-defense capital goods orders excluding aircraft, seen as a signal of business spending, rose a much larger-than-expected 1.5 percent. Analysts had forecast a 0.4 percent rise in the category.

"The headline was disappointing, but that was offset by a much stronger-than-anticipated reading in the non-defense capital goods orders ex-aircraft component. That provided some reassuring news in terms of corporate business investment," said Alex Beuzelin, senior market analyst at Ruesch International in Washington D.C. "At the margin, this supports the view that the Fed's job may not be done yet."

I put it all together and I'm just not sure that the incoming data is convincing enough yet to substantially alter our forecasts about the general health of the U.S. economy.   

I should emphasize that I am very far from sanguine about those forecasts.  There has been a spirited conversation of late -- at Econbrowser (here, here, and here), at Greg Mankiw's Blogat Economics Unbound, at Outside the Beltwayat Brad Delong's Semi-Daily Journal -- on when we ought to date the beginning of the last recession.  It is an interesting conversation, but every speech I give these days includes these two pictures:





I've said it before: No matter when you date the official beginning of the last recession, there is absolutely no question -- none -- that the slowdown began in earnest mid-2000.  And that despite the fact that everything looked just fine before the bottom fell out.

I haven't forgotten that lesson.   

UPDATE: More related commentary can be found at Alpha.Sources (here and here), at The Big Picture (here and here), at Calculated Risk (here and here), at Economist's View (here  and here), and from The Skeptical Speculator.

August 25, 2006 | Permalink


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Tim Duy wants help with his homework: 37 Charts – In No Particular Order, by Tim Duy David Altig discusses the challenge macroeconomists face as they aggregate a dizzying array of economic data into a coherent story: To put it [Read More]

Tracked on Aug 25, 2006 5:38:37 PM


"Dallas Morning News" Business writer Danielle DiMartino addresses the dilemma '07 ARM resets are likely to (will) pose for Fed in this morning's piece:
I've got nothing to add, I'm still reconciling our Fed's spending/saving dilemma to the Mkt's call for '07 ff rate cuts. Have a great day.

Posted by: bailey | August 25, 2006 at 08:22 AM

Bernanke’s testimony (to which you link) was over a month ago. If you look at all the housing indicators that have come out in the intervening time, they paint a picture of a housing sector that is declining much more rapidly than Bernanke might have anticipated (certainly more than I anticipated) at the time of his testimony. And during that time my own expectations have shifted to putting the greater probability on a hard landing (which I define as a slowdown with net declining employment over time – maybe or maybe not an actual recession). Various flashes of good news from non-auto industrial sector are one reason that I still think there is a significant chance of avoiding a hard landing, but if I had to bet (and since I have assets to invest, I do have to bet), I wouldn’t bet on a soft landing.

Posted by: knzn | August 25, 2006 at 08:39 AM

"More to the point, softening in housing markets, and attendant consequences on consumer spending and GDP growth, are already embedded in every reasonable forecast. They also include the expectation that the future will in part bring a rising share of business investment along with a falling share of household consumption."

And every reasonable forecast in 2000 already put in the falling stock market into the equation. And yet a survey of 50 top prognosticators, and not one predicted a recession.

Posted by: edhopper | August 25, 2006 at 09:53 AM

No one is saying you're stupid or mendacious; we only have a slight disagreement on the future dx/dt of housing.

You're being a proper restrained academic and waiting for more data, while market participants typically require a more aggressive analysis; by the time a hard landing becomes accepted wisdom it's been discounted to zero value in the market.

On a more personal level, I've been reading your blog for months; you never disappoint; thanks for making the effort.

Posted by: eightnine2718281828mu5 | August 25, 2006 at 10:06 AM

I've been in this business since the early 1970s and include the 1971 recession in my memory bank.

The consensus has never forecast a recession -- it is always for a soft landing, just as the consensus always forecast a weak recovery.

Moreover, I've developed my own theory that it is all but impossible for the consensus to correctly forcast a recession.

Recessions develop when the business community as a whole
makes a mistake and accumulates unwanted inventories or as in the last cycle unwanted investments.
But plans are based on the consensus forecast, so for the consensus to forecast a recession
it has to forecast that the consensus will be wrong.

A parallel developemnt is that it is extremely difficult to get the large scale econometric models that many forecasters use to produce a recession forecast.
That is because the models have built into them that markets clear,but recessions develop when markets do not clear.

I know this is a weird theory, but it is based on experiencing 30 years of watching recessions develop as a business economist.

Posted by: spencer | August 25, 2006 at 10:47 AM

interesting to me has been the dating of the end of the last recession. if you push it forward to when industrial production bottomed the second time, in mar 2003, a lot of the recovery data make more sense in terms of the relation to other recoveries.

Posted by: steve blitz | August 25, 2006 at 10:59 AM

The part that is so difficult with this, is that this time "it really is different" as they say. Never in the history of our country has so much of our "wealth health" been generated by a housing bubble using credit withdrawl and taking massive loans from foreigners to subsidize our huge and growing trade deficit. So I don't really think anyone out there can actually predict the outcome when the bubble gets pricked, which, whoops, just happened.

Will the banks, those rocket scientists who funded new see through office buildings next to the empty see through office buildings in the last commercial building bust, wind up owning real estate they don't want worth less than they loaned on it, well of course they will, etc. etc.
And don't wait for GM and the boys to pick up the slack so the picture is potentially grim, but (bugle blows, Bernake and the Chinese troopers enter stage left in a cloud of dust, but I just can't make out how small the surviving party is through the dust)

So I don't really know if it will be hard and soft, but I am certain that Helicopter Ben is going to get a chance to be that legend. If Greenspan could go to 1 and BOJ could go to zero, the solution is so simple. Fire up the presses, crank down the ffr, and wave the flag. And of course China will step up to the plate and loan us whatever we want, because they don't want their economic junkie to quit absorbing their output yet because we haven't been sucked dry yet. Now some of you nitpicky academics will say this will produce runaway inflation down the road, but THE PARTY MUST GO ON, this is America the wonderful after all.

So a nasty problem (the recession) resolved with an ugly solution (low interest rates), leading to our second problem of one wrong + one wrong = OUR ECONOMIC FUTURE, by the way, Paul "Cigar" Volker is still available, isn't he?????????

I think that sums up the big picture, all that is left is to see how the little pieces fit into it.

Posted by: badbear | August 25, 2006 at 11:26 AM

"But plans are based on the consensus forecast, so for the consensus to forecast a recession
it has to forecast that the consensus will be wrong."

Anyone willing to expand on this, or unwrap it a bit. I understand "plans are based on the consensus forecast." But what is "it" in "it has to forecast that the consensus will be wrong."

There seems to be something akin to circular logic here.

There are (1) individual forecasts (2) consensus forecasts (3) plans and (4) outcomes. Plans are clearly driven, to a degree, by forecasts, but to what degree? Seems to me a lot of plans are driven by what happened yesterday, not forecasts about the future.

So I understand that some circularity exists, between plans and forecasts, but still, tiven that, I'm having trouble with the quote and I'm sure it is trying to tell me something that I should understand.

Posted by: T.R. Elliott | August 25, 2006 at 11:59 AM

If you are going to forecast a recession what you have to do is forecast that business will prepare for x% growth in sales -- the same as projecting that output expands by x%. But you also have to forecast that actual demand growth is something less than x% growth so that business is left with unwanted output
so that have to cut production to bring demand and supply back into line.

Recessions occur when supply exceeds demand, but no one every forecast that-- they always forecast that demand and supply balance. When supply exceeds demand the business community has made a mistake, but no one ever forecast this.

Does this answer your question?

It is not a question of plans vs forecast, it is a question of making a mistake.

Posted by: spencer | August 25, 2006 at 01:03 PM

think about how a recession develops. Production exceeds demand so inventories build. So
the second step -- the actual recession -- is business cutting production below demand to sell off the excess inventories. Once this happens you can go back to a normal environment where demand and supply balance.

Looked at this way, you see that a recession is simply an error correction process.

Normally it is inventories, but in the last cycle it was capital spending.

Posted by: spencer | August 25, 2006 at 01:15 PM

Look at a current example. Ford is cutting production of pickup trucks. Why? Because they overestimated how many trucks they would sell and now they have too many trucks in inventory. So how do they eliminate that surplus inventory. They cut production to below the current sales rate so that demand exceeds production and they can meet some of the demand out of the surplus inventories.

Ford made a mistake in planning or forecasting and now they are correcting that mistake. But the correction is to cut production below demand.

Take this across the entire economy and you see that a recession is simply an error correction process.

Posted by: spencer | August 25, 2006 at 01:23 PM

Spencer: I'm with you on your comments about markets clearing. And I understand your points about supply and demand. But I'm still thinking: does a recession necessarily occur when supply exceeds demand? I don't think so. The definition of a recession, from what I can tell, is a decline in GDP (or business activity). It seems to me that an imbalance between supply and demand might result in slower growth, not a recession.

I don't know enough about macroeconomic models, but it seems to me that the primary consideration for recession is not whether markets clear or don't clear, whether supply is larger than demand, but the SIZE of the imbalance: Whether the imbalance is large enough to lead to negative growth.

So taking your point (which I'll assume for want of any other information) that macroeconomic models assume markets always clear, does not immediately tell me that this is the reason they don't predict recessions.

I do agree with your word "mistake." I think it likely--again, I'm not an economist--that recessions aren't predicted because economists cannot predict when the psychology chances, and it is the change in psychology, the herding instinct, that makes the recession impossible to predict.

I think macroeconomists can easily say that, on average, there will be X recessions during a particular time period, say over 20 years.

But they can't predict an upcoming recession because the fundamentals truly don't predict the recession: at some point, the crowd psychology simply changes. And there isn't much that will predict that.

I've not looked into any of this in detail. But over at Econbrowser and elsewhere, for example, there are still quite a few debates on when the LAST recession occurred.

If we're really not sure when the last recession occurred, we absolutely have no clue when the next one will. So the models probably predict more-of-the-same with a few deviations up and down, but not enough to call for recession. And it seems like psychology is the missing ingredient in the models, not the clearing of markets.

Thoughts of a physicist-not-an-economist.

Posted by: T.R. Elliott | August 25, 2006 at 01:36 PM

Work the numbers.

Ford planned to sell/ produce 10,000 trucks.

but they only sold 8,000.

So now they have 2,000 unwanted trucks sitting on dealer lots.

But they do not cut production to 8,000. Rather they cut production to 6,000 so they can sell both the 6,000 they are building and the 2,000 in inventory.

So a 20% mistake in planning leads to a 40% cut in output.
That is the recession.

But even if demand stays at 8,000
once they have eliminated the 2,000 excess inventory they can take production back to 8,000 -- a 33% increase from the 6,000 level. The going back to 8,000 output would be the economic recovery.

Posted by: spencer | August 25, 2006 at 01:41 PM

Good points, Spencer, but I suspect that your viewpoint is overly simplistic. Thinking about what I have spent during the last week, a significant portion of it was not on things/services that have an inventory. An increasing proportion of our economy is not manufacturing-based.

Posted by: cb | August 25, 2006 at 01:47 PM

Spencer: I understand your examples. Without much thought, I think the greatest recessionary pressure will come from automobiles and housing. Energy is and will likely to be expensive, so we're probably seeing a change in the psychology regarding large SUVs and trucks. In addition, housing is a bubble (I don't think gains here in San Diego in the past couple years could be described otherwise).

But these specifics have to be mixed into the overall economy, as pointed out by CB. And while true that the recession is caused by imbalances between supply and demand, what we're talking about is prediction. And if the economic models--macro or micro--could predict the psychology, then demand and supply would be more closely balanced.

But in the housing sector, for example, I've read that that the homebuilders don't even try to predict, by and large. They build based on current demand, and build as fast as they can. They'll ride the bubble all the way to the top and then, when they have inventory left over when the bubble pops, they'll just consider any losses to be part of their business expenses.

Though realistically, are builders really losing money when the price of a home drops by $100K? Money they might have had. But I wonder how much it really costs to build a $800K house. When the price drops to $700K, or $600K, is the builder taking a bath? Probably not.

As I said above, the macronomic models are probably too much driven by stay-the-course, like an aircraft carrier, and the change in psychology is like an humongous iceburg.

Posted by: T.R. Elliott | August 25, 2006 at 02:06 PM

Building costs are about $100/sq ft, probably somewhat more with recent price increases. Most of the value in urban areas is in the land so whether they take a bath or not depends on their land commitments and when they made them, that is, what they paid for them.

Posted by: Lord | August 25, 2006 at 02:34 PM

already embedded in every reasonable forecast

But not the stock market, I think.

Posted by: Lord | August 25, 2006 at 02:36 PM

Paul Kasriel has an interesting take:

"August 25, 2006

New Homes Market: Worst Supply-Demand Situation Since Early 1970s
by Paul Kasriel

This is just a follow up from Thursday's report on new single-family home sales for July. Asha told you that new single-family homes sold in July were down 22.2% from year-ago. As sales of new homes cratered, new homes for sale in July skyrocketed up 22.44% from year-ago (see Chart 1). Subtracting the change in new single-family homes for sale from the change in homes sold yields the data contained in Chart 2, which is not pretty for July. The difference for July 2006 is minus 44.66% -- the most negative reading since July 1972. By this measure, then, the supply - demand situation for new single-family homes is the worst since the early 1970s. This suggests that "effective" prices - i.e., prices adjusted for free granite kitchen countertops - will be falling in the coming quarters and that residential construction activity will continue to contract. Falling new home prices will put downward pressure on existing home prices. Downward pressure on existing home prices will have a negative impact on consumer spending in that home equity available to extract will be growing at a slower pace or even declining. Downward pressure on exiting home prices also could lead to increased mortgage defaults as home-"owners?" wanting to term out their adjustable rate mortgages may find the amount needed to be refinanced is more than the new lower appraised value of their home. Today H&R Block announced that it setting aside $102.1 million as a result of increasing mortgage delinquencies being experienced by its mortgage-originating subsidiaries. Folks, the bursting of one of the biggest U.S. housing market bubbles, if not the biggest, are going to have a significant negative effect on the rest of the economy."

Posted by: me | August 25, 2006 at 04:49 PM

You would also do well to take a look at the New Home sales and rece4ssions charts at Calculated Risk.

Posted by: me | August 25, 2006 at 04:52 PM

So if I were to ask you: "Will there be a recession within two years?" and you could only answer yes or no (no probability answers please) what would you say?

Posted by: sharkbait | August 25, 2006 at 09:58 PM

I wonder what kinds of numbers it would take before David actually DID start to worry about the state of the economy?

Posted by: JH | August 25, 2006 at 11:21 PM

Economy will be fine. It will all pass with in the next 2 years.

Posted by: Melissa | August 27, 2006 at 02:42 AM

sharkbait -- no

JH -- I always worry (its my job). But I do have a suspicion that in the past month or so the conventional wisdom has shifted a little too far toward the rapid-weakening meme and correspondingly less concerned with the inflation numbers than is warranted. But I agree the next three months loom large in determining whether the current weight of sentiment is justified.

(Spencer et al -- nice discusion.)

Posted by: Dave Altig | August 28, 2006 at 09:47 PM

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