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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June 27, 2011

Stimulating small business activity: Still a struggle

In testimony before Congress on June 22, U.S. Treasury Secretary Timothy Geithner laid out the disproportionate effect the financial crisis has had on small businesses and particularly their ability to raise funds:

"The banking and credit component of the economic crisis was especially damaging for small businesses, which are more dependent on bank loans for financing than are larger firms. Alternative forms of financing, through household credit via mortgages and credit cards, were also deeply compromised by the financial crisis. Mortgages and other loans account for four times the share of liabilities for non-corporate businesses as they do for corporate businesses. Total lending to non-financial businesses shrank for nine straight quarters starting in the fourth quarter of 2008, before turning slightly positive in the first quarter of 2011; on net, lending has declined by a cumulative $4.2 trillion since Fall 2008. Over the same period, larger businesses were able to raise $3.6 trillion by issuing debt securities."

Evidence from the Atlanta Fed's latest small business finance poll of approximately 182 firms in the Southeast confirms that many firms are still struggling with financing. Total financing received among repeat poll participants edged up only slightly in the first quarter of 2011 from the previous quarter. Further, 43 percent of participants overall reported that tighter lending practices are hindering access to credit. In addition, when offers of credit do occur, they often do not materialize into loans as a result of the unfavorable credit terms being offered. In fact, 41 percent of applications to community and regional banks and 57 percent of applications to large national banks were refused by the borrower, according to the first quarter poll.

In response to these ongoing problems, the Administration has created several programs to help small business obtain funding. One is the Small Business Lending Fund (SBLF). Created by the Small Business Jobs Act in September 2010, the fund began accepting applications in December 2010. The SBLF was set up to provide an incentive for financial institutions with less than $10 billion in assets (mostly community banks) to boost lending to small businesses.

Under the terms of the program, the more small business lending increases, the greater the benefit to the institution. In theory, shoring up the balance sheets of the banks in exchange for an increase in small business lending would result in an increase the amount of loanable capital. Further, there would be a greater opportunity cost for failing to bring loans to closure, and this cost could result in borrowers receiving more appealing credit terms. As a result, those small businesses currently rejecting loans based on the cost of funds could see credit terms ease, resulting in more acceptances and an expansion of small business loans. (You can read more about the details of the SBLF here.)

Unfortunately, the program, which closed out June 22, was not very popular. As of the morning of June 22, the Treasury had received 869 applications out of 7,700 eligible lenders. All together, they requested only $11.6 billion out of a possible $30 billion from the program.

Why was participation so low? One potential reason is lack of demand. According to Paul Merski, chief economist and executive vice president of the Independent Community Bankers of America, "You're not going to pull down capital unless you have loan demand."

If demand for small business loans is not expected to pick up, then what is restraining demand?

One possibility that we considered in a macroblog about a year ago is that demand is being restrained as a result of the perception of tight credit supply. Creditworthy borrowers could be assuming they will be denied so they are not applying. Another possibility is that demand is constrained because of economic weakness. To get a handle on the extent to which these factors are restraining demand, we turn back to our small business finance poll. In the poll, we ask those who did not seek credit in the previous three months why they didn't seek it. The chart below shows the responses to the question. (Note that survey participants can check more than one option.)

At first glimpse none of the reasons seem to dominate. However, if we categorize the responses into "I didn't need credit" and "I didn't think I'd able to get credit," the graph becomes a little more useful.

The graph below shows the responses placed into these two categories (where possible). Firms that only marked "sales/revenue did not warrant it," "sufficient cash on hand," or "existing financing meets needs" are put into the "I didn't need credit" category. Meanwhile, firms that only said "unfavorable credit terms" or "did not think lenders would approve" fall under "I didn't think I'd be able to get credit."

We do not claim that our survey is a statistically representative sample, and we of course can only reach existing businesses. The survey is silent on potential new businesses that were not formed because of credit issues that the SBLF could potentially address. With those caveats, we do find that the majority of firms (66 percent) did not borrow because they didn't need to or want to. Whatever the merits of the SBLF program, it appears that understanding why those businesses that are fully capable of expanding are not doing so is at least as important as understanding the slow pace of SBLF activity.

Ellyn TerryBy Ellyn Terry, an analyst in the Atlanta Fed's research department

June 27, 2011 in Small Business | Permalink


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Banks and businesses large and small are stuffed to the gills with cash. Two things that could induce them to spend it are: rising inflation and rising interest rates. Two things the central bank fights hardest to do: hold down inflation and flatten rates to zero as far into the future as possible.

Posted by: Carl Lumma | June 28, 2011 at 11:27 PM

It is the community banks in this country that better serve small businesses. They are important customers at our small banks.
The SBLF will probably only disburse about $2 to $3 billion of those funds because of dividend restrictions imposed on many community banks by the federal reserve as a result of the economic crisis.
SBLF could make a difference because it hits home. Rigth were small businesses need it, at their local community bank.
If you have a business with revenues less than $1mm per year you are not an important customer at the larger banks and they will not assist during this recession.

Posted by: carlos safie | June 29, 2011 at 07:17 AM

Rising inflation can only induce someone to spend money IF they were predetermined to "want" the item, or investment, prior to the bout of inflation. If I "wanted" to buy a new car that costs $20,000 but did not "need" the new car, please explain why the car suddenly costing $25,000 would prompt me to rush out and spend my capital on it? I would assert that it wouldn't. Rising inflation on investment opportunities in fact makes the investment opportunity less compelling not more.

The same holds true for rising interest rates. Rising interest rates only prompts would be borrowers to rush out and secure debt financing if they "wanted" it before the interest rate increases. If they didn't "need" debt financing before, they sure don't perceive themselves as needing debt financing when it is more expensive.

Business small and large have become increasingly risk averse. Debt financing for ANYTHING makes a business riskier not less. I would also assert that debt financing for existing operations adds very little (if any) value to the business. Debt financing for new capital projects CAN add value to the business BUT it also increases risk to the business. Thus, in a world of more risk aversion there is naturally less demand for loans a.k.a. leverage.

The underlying secret that is spreading among businesses is that the "just add leverage" American way is not a sound business strategy. Many businesses of all sizes have caught on to this fact. They seem to only be considering taking out debt financing if they "need" it.

In my opinion a tremendous factor in the increase in risk aversion is the outrageous cost of failure that has only been increasing over the past 30 years. Ironically this is largely because of inflation. Most start-up businesses cannot afford healthcare for their owners or employees. Start-ups initially struggle to provide enough cash (let alone income) to provide for food, transportation, technology, etc. This is only worse when the entreprenuer has a family...as he or she is obligated to provide for other people. So, not only will the start-up struggle to provide for their family...in the event it goes under they will be facing tremendous losses, increased costs through bankruptcy issues, AND they will STILL be obligated to provide for their family (with less resources).

Even a less extreme case...lets just say I wanted to go back to graduate school to secure a better job in a different field or start my own business after school. I will have to take out a student loan that cannot be dissolved EVER and is typically required to be paid back in 10 years (as I understand it). That is potentially over $100,000 in debt that, in the event things don't pan out well, will be a plague for the rest of my life. Repeat the same process of not being able to provide the basic necessities of life such as food, clothing, healthcare, shelter, etc. to my own family and hopefully you will get my point.

You want to increase small business activity? Stop trying to engineer inflation...and reduce the cost of failure to those with a good idea and the drive contribute to society by creating their own business! At least that is my idea for the moment.

Thanks for your time and have a happy 4th of July.

Posted by: Danny | June 30, 2011 at 05:02 PM

We are finding that it difficult to force businesses to borrow money. The main reason a small business wants to borrow is if they see demand expanding for their goods or services. If small business owners don't see demand rising for their products, they will NOT want to take on MORE risk by borrowing. Low interest rates, gov't programs, tax credits, lower taxes, and a plethora of other programs will NOT make a difference. It will not encourage small businesses to borrow.

The problem may be very complex, but the widening income gap in the U.S. has to be part of this issue. If the average consumer has a smaller share of the economy, then it stands to reason that their consumption percentage of the economy will be lower.

The trickle down theory that Republicans seem to be wedded to, will only result in the U.S. economy trickle down the list of vibrant economies.

The great economic expansion that we have enjoyed from the 50s through the 90s was directly attributed to the rise of the middle class and their increasing share of the U.S. economy. If politicians want to reinvigorate the economy, perhaps they should consider how our national income and taxes are distributed throughout our society.

Posted by: mattinmanhattan | July 02, 2011 at 09:46 AM

It is not that I disagree with the idea that "demand" comes before investment or at the very least concurrently, but in fact it is the disingenuous efforts of politicians to use the notion that demand comes first to waste hundreds of billions of dollars on unproductive crap that is in reality designed to do little more than help them win election. At the core, state capitalism works the same way the private enterprise system works if either are to succeed: over the long run both have to make investments that are at best profitable or at worst economically feasible. In the U.S. we happen to be cursed with politicians who do not have the personal responsibility or accountability or historical track record (in the past 20 years) of making such decisions. Thus, many people find the notion of the free market system far superior to that of state run enterprise.

On the wealth gap. I have started to ponder a new notion of the origin of the existence of a wealth gap which has been expanding in the past 20 years. Presently I believe that the disparity between the middle class and the upper class stems from poorly constructed rules, regulations, and incentives. In a world in which the government can craft "perfect" rules/regulation the chances of wealth creation are reasonably fair between the economic classes. Yes there are probably disparities that still exist, but from 1950-1990 there are countless examples of rags to riches or probably even more plentiful rags to a great middle income lifestyle. In the world with perfect regulation income becomes more of a function of true work ethic.

However, in a world of less than perfect regulation...there is an arbitrage that takes place between the better mentally equipped, and financially backed people, and the middle income or poorer classes of people. Quite simply the vast majority of the brain power (which is a minority of people) invests the majority of time determining how they can make the most money in a relatively easy fashion. Why do you think there are SO many terrible lawyers in the world?

Having imperfect rules to the game isn't the only ingredient to an expanding wealth gap. A general decline in morality has to occur as well. It is not enough to have the opportunity to screw other people for money but rather you have to have the desire to do it as well. It doesn't have to be necessarily malicious. It can simply be as easy as a doctor who charges different rates depending on what insurance provider you use. While I am sure there are rules against such a thing, try to keep a straight face and say it doesn't happen on a WIDE scale. Bet you can't do it.

What we need in my estimation is to stop trying to craft the perfect regulation. Begin re-incorporating ethics/morality/human interests into the classroom and probably most importantly the business, legal, medical and any other professional classroom. Sure there have been significant increases in ethics topics in classrooms but I would assert those too are primarily focused on the letter of the law and not the spirit of it...which I would argue is "don't try to screw other people for a living".

Imagine a world where businesses, individuals, and politicians made decisions for their own self interests BUT made a conscience effort to align their self interests with that of society as a whole?

Don't make it so easy on the rich to keep getting richer. They are smarter than you or I. Make it easier for the middle income or poor people with a good idea to experience manufacturing and monetizing that good idea. Just some additional pennies of my thoughts.


Posted by: danny | July 06, 2011 at 09:57 PM

The great economic expansion that we have enjoyed from the 50s through the 90s was directly attributed to the rise of the middle class and their increasing share of the U.S. economy.

Posted by: small business web design | October 11, 2011 at 01:12 AM

I especially like the comment where you stated "If demand for small business loans is not expected to pick up, then what is restraining demand?". Very good point indeed.

Jeffrey Lynne

Posted by: Jeffrey Lynne | January 29, 2012 at 05:39 PM

Middle classes have to struggle a lot to keep pace with the today's advancement. There are a lot of job opportunities created for them due to economic development. But it isn't a stable situation.

Posted by: engineering resume | July 07, 2012 at 11:01 AM

I don't know if they have any more tricks up their sleeves to defrost the credit markets. I don't know a lot of small businesses successfully getting small business loans.

Posted by: John Walters | July 13, 2012 at 11:10 PM

After the huge recession a number of small business including large business ventures are lost its shines due to lack of funding and outputs, as small business are totally depend upon bank loans for their funding therefore they are severely effects during the period of recession.

So in response to save the small business banks are really played an essential role in the developing process.

Posted by: Tim Swager | October 26, 2012 at 08:26 AM

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June 13, 2011

Core cuts both ways

With the six-month average of annualized headline inflation running just over 5 percent, this Wednesday's consumer price index (CPI) report looms a little larger than usual. While it is dangerous to predict such things, there is every reason to believe that the measured increase in CPI inflation for May could be quite low. And there is every reason to believe that this softness will persist into June.

The reason is quite simple. Movements in gasoline and fuel prices really do push around the headline inflation number, and at long last it looks like that movement is in the downward direction. Here's the relevant picture:


Let's assume that, annualized, CPI excluding food and energy rises 2.1 percent, as it has so far this year, and food and nongasoline energy prices each rise at 5 percent. Then when you plug in gasoline prices already realized for May and EIA predictions for June, you get a 0.4 percent rise in the headline CPI in May and a 0.7 percent decline in June (both rates annualized).

Despite some probable relief on the headline inflation number, I remain aware of what that relief means and what it does not. Earlier in the year, Atlanta Fed president Dennis Lockhart had this to say:

"I want to contrast inflation to the cost of living. In casual language, we often interpret a rise in the cost of living as inflation. They are not the same thing. Cost-of-living increases are a result of increases in individual prices relative to other prices and especially relative to income. These relative price movements reflect supply and demand conditions and idiosyncratic influences in the various markets for goods and services…

"… The Fed, like every other central bank, is powerless to prevent fluctuations in the cost of living and increases of individual prices. We do not produce oil. Nor do we grow food or provide health care. We cannot prevent the next oil shock, or drought, or a strike somewhere—events that cause prices of certain goods to rise and change your cost of living."

Two points, then. First, even if things evolve as the chart above suggests, the level of gasoline prices will remain relatively high by recent standards. Low inflation readings for the next couple of months would therefore leave the cost-of-living high by recent standards, a fact that is not lost on us here at the Atlanta Fed.

Second, as President Lockhart's comments reveal, we were reluctant to attribute the run-up in fuel prices to monetary policy. And I imagine we will be equally reluctant to credit monetary policy with any relief from that trend.

In fact, I will fearlessly predict that, should our guess here about headline inflation in the next couple of months be proved accurate, we will point to core inflation measures as reason to look through some very low inflation readings. See these comments from President Lockhart's most recent speech for some additional perspective:

"Are the recent outsized increases in headline inflation the best signals of the inflation trend going forward? Or are other statistics—like core inflation or measures of inflation expectations—yielding a truer picture of what lies ahead?

"The answer matters a lot. And it certainly weighs heavily on my thinking. I would not hesitate to support an exit from our current policy stance if I believed that the headline inflation number of the past six months is really indicative of the underlying trend inflation rate. I don't believe this to be the case. And I am wary of tightening monetary policy in the face of quite ambiguous economic circumstances unless doing so is absolutely necessary to meet the FOMC's price stability mandate."

And here's why it matters, quoting President Lockhart from an interview with Reuters last week:

"In the interview, Lockhart said maintaining an easy Fed policy stance should ensure the moderate U.S. recovery does not fall off the rails."


"How high would the bar be for further Fed easing?

"It would take 'a significant deterioration as reflected in the overall economy, a set of deflationary signals and also unemployment numbers that rise dramatically. Last fall (when the Fed launched QE2), by some measures, we were seeing declining inflation expectations that were headed in a pretty negative direction, and that was happening pretty rapidly. We were in a disinflationary environment. So the risk of deflation was plausible. We acted and the situation has turned around. That was, at least in my way of thinking, very central to supporting the policy. We don't have anything remotely like a deflationary risk at the moment, short of a shock of some kind.' "

If what I suggest above—falling headline inflation, stable core inflation—comes to pass in the near term, don't expect me to start ringing the disinflationary bell.

This isn't the last word on the usefulness of core inflation statistics, and the debate is certain to rage on (see here and here, for recent installments). But I do hope that this post is remembered the next time the Federal Reserve is accused of hiding inflationary pressures behind the rhetoric of core.

Update: The May CPI report is in, and once again the facts trump arithmetic. We got the flip in the headline/core measures right; the rest, not so much.

Update: Here's one way to construct a synthetic CPI:


CPIHeadline(T) is the calculated value of the seasonally adjusted CPI in month T > December 2010. CPIHeadline(Dec2010) is the reported seasonally adjusted headline CPI for December 2010. CPIFood, CPICore, CPIGas, CPIOtherFuel, and CPIHHenergy are the seasonally adjusted component level CPI indexes for the above mentioned components. Note that this formula will not exactly replicate the January through April 2011 headline CPI since the components are not granular enough. When using the above formula to compute CPIHeadline(Apr11) and CPIHeadline(May11), we compute one-month headline inflation in May 2011 as the percent difference between the values of CPIHeadline(Apr11) and CPIHeadline(May11), both calculated with the above formula (i.e., do not use the reported value of CPIHeadline(Apr11)). In our calculations we used the same inflation assumptions for "other motor fuels" and "household energy" (both increase at a 5 percent annualized rate in May and June). By Patrick Higgins, an economist at the Atlanta Fed

David AltigBy Dave Altig, senior vice president and research director at the Atlanta Fed

June 13, 2011 in Deflation, Federal Reserve and Monetary Policy, Inflation, Monetary Policy | Permalink


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Can you share the exact equation to create headline inflation given Core, food and non-gas energy, and gas prices?

For example, assume core at 2.1%, assume food and non-gasoline energy go up at 5%, then plug in some gasoline price. Whats the exact equation?


Posted by: TC | June 13, 2011 at 10:12 PM

Dave thinks that we will have a negative print for CPI in June. I will wait and see if that happens. I doubt it.

I can't understand how Dave and the others at the Fed can push this kind of thinking. Bernanke has said several times that QE has brought us high stock values. The same forces that raise equities push up other asset classes as well. You can't get only "good" inflation when the printing presses are running and ZIRP is a three year long policy.

It would behoove the Fed to acknowledge their role in the run up in global inflation. When they try to deny the obvious connection they just lose credibility.

Posted by: Bruce Krasting | June 14, 2011 at 06:46 AM

Hi Bruce,

Read your work constantly and like it. Don't always agree, but it is good.

If oil falls to $90, we're going see negative headline CPI, period. There is a strong chance we will see far greater declines in the price of oil once Libya comes back on line. Germany just recognized the rebels as the legitimate government of Libya.

The headline inflation is being caused by a massive speculative bid under oil. This speculative bid in oil is very likely to get crushed. It could happen as soon as this week. Once that happens, then we're going to see a long string of negative CPI prints.

Posted by: TC | June 14, 2011 at 09:38 AM

TC - It's fairly straightforward to derive the weighting of gasoline from the example given.

The (rather straightforward) general calculation method is given by Wikipedia; specifics are maintained by the BLS.

Posted by: Ken Houghton | June 14, 2011 at 12:53 PM

TC. Tks.

Your comments on Libya and short term movements in crude make an excellent point:

The way we/the Fed measures inflation is flawed.

Yes, energy is a critical variable in the CPI. What is missing is how things are creeping up on us.

How about higher education? 25% per year sound right?

Health care Ins? At least 20% per year.

Transportation, clothing or rent? Try 10% in the last 6 months.

How about silly things like tolls or even traffic fines? 30%?

Seen the price for a bag of cement lately? Roofing shingles? Copper fittings? Nails? PVC pipe? It's across the board.

Food is off the charts. The Fed knows this. I'm sure that some of the folks who work there actually go to a store once in a while and sees what is going on.

But they have the nerve to tell us that things like an IPAD remaining stable in price while the CPU has increased is a net reduction to the real things we have to buy.

No sale. Sorry.

You may not agree with what I write. But consider the words from Bernanke way back in 2003. I wrote about it today. This blog brought on my effort. Forget my words. Focus on Ben's. In particular, the last quote in the article.


Posted by: Bruce Krasting | June 14, 2011 at 08:32 PM

Excellent work, David.

Could you explain the Fed's logic for requiring such a high bar on further monetary easing?

Suppose core inflation stayed roughly where it's at -- well below 2 percent, and unemployment stayed roughly where it's at, around 9 percent, perhaps coming down only very gradually.

You're saying the Fed's going to do nothing more in this case.

Is there a reason for that?

And, can you make a distinction between the Fed's strategy and the Japanese Central Banks' strategy circa 1993-2011?

@Bruce Krasting: If QE causes inflation in commodities, 1 for 1 increase in Excess Reserves notwithstanding, then how come most of the QE came in 2008, and yet we've had core inflation below 2% for three years in a row now? Seems like high unemployment and low AD are keeping a lid on your wage-price spirals there, just as theory says it should...

Posted by: Thorstein Veblen | June 14, 2011 at 10:08 PM

Fairly basic economic theory can explain changes in prices for a specific product, service, or commodity, or "good". There are only three possible factors:

1) Supply curve
2) Demand Curve
3) Money supply (in the widest possible measurement)

The first two are market driven forces, a function of human beings making choices in the backdrop of whatever economic system in which they operate (which is now quite global). Exogenous forces such as the government distort the supply or demand curves through policy (such as subsidies, price controls, war, tax code, etc). Natural factors such as whether or climate, or the existence or lack thereof natural resources can affect both curves.

But the ability of a government (via a central bank, typically) to expand or contract the money supply affects prices in a predictable way, holding all other things equal. Remember that simple phrase?

Changes in prices of goods as a result of supply and demand is NOT inflation. They are simply...changes in prices...which is a normal part of a market economy.

Indeed, over time, absent monetary inflation, REAL prices of goods tend to gently decline, as a result of technology. And this gradual decline in prices is how we improve our standard of living over time. It is INCREDIBLE that this basic economic fact is now lost.

The reason there is a source of confusion is how "inflation" is measured. The central bank specifically wants us to think of it in terms of changes in prices. But this is misleading. the proper meaure of inflation would be the increase in price aboe the level where it otherwise would be...were we not to have monetary expansion.

We can have 0% change in the CPI...and still have inflation. Take housing: if we had not had the massive monetary expansion in the last two years, housing prices would have DECLINED much more and much more rapidly. As such, prices are INFLATED...they are being propped up. This is every bit as inflationary as prices increasing as a function of monetary expansion.

The Fed has blurred the line among supply, demand, and monetary expansion...and how much eaach of these affect prices. They don't WANT market participants to be able to isolate the effect that monetary expansion has on prices. In that way, the government can inflate, as we don't easily see just how much dilution of the dollar we are experiencing. Notice the persistent talk about how declining prices are synomomous with DEFLATION, and how this is supposedly bad. A free market will produce naturally declining prices, i.e. a greater standard of living via greater purchasing power. And this is regarded as negative?

Or...we allow an inflation bubble to pop, and the artificial prices brought about by monetary inflation return to where they should be...and this is negative?

It is only negative to the government itself, or to those participants that benefitted from the inflation in the first place. The rest of us are gradually payings its price...through a stealth (and at times not so stealth) decline in the purchasing power of our currency.

Posted by: Chris | June 14, 2011 at 11:35 PM


I wrote about this recently. Go to the 6th chart. It tracks the growth of the Fed's balance sheet (QE) and the CRB.

The correlation between the two is 85^2. In my world that is a very tight correlation. It could not be this high by coincidence.

Review the chart and make your own conclusions.

You may respond; Baloney! The CRB is not the CPI! And you would be right.

I say that CPI is a lousy yardstick. Core is even worse in my opinion. But that is what is used to establish monetary policy.

* CPI-W is up 3.5% in the past six months. Inflation is ripping at an annual rate north of 7% by this measure. That's 3+Xs times the rate of "a little below 2%" that Bernanke has promised.

* High quality arable farmland has doubled in price in just the past three years.

Who's gambling with inflation? I think the Fed is.

Link to article with charts:

Posted by: Bruce Krasting | June 15, 2011 at 08:44 PM

Hi Bruce,

I am not sure exactly what should be included when measuring inflation, and I am convinced nobody really knows for sure. There is no perfectly accurate measure of inflation, and all of the points you mention are very true.

But the government measure of inflation is pretty good. I'd say it is one of the best measures we have. I think this for a few reasons, but the most obvious is that we have yields from the bond markets that need to make sense when we compare them to inflation.

If inflation is being undercounted - like you are claiming here and I've seen you claim in other places - the U.S. government will actually make money when it issues bonds.

I go over the math in a post at my place, but I am sure you know it too. It's standard line MBA style thinking on rates. (1 + Treasuries) = (1 + inflation)*(1 + real rate)


I call it the hyperinflation hoax, because if we were seeing high levels of inflation, the best way for the U.S. to reduce its debt to GDP would be to borrow more money. Nonsensical results like this make the argument for any inflation much higher than 3% suspect, IMHO.

The real rate of return or real yield is what matters for the government. If inflation is anything higher than the BLS says it is, then the government is "paying" a hugely negative rate of interest even on the longest bonds. Paying a negative rate is the same as getting paid. If inflation is higher than 4%, the U.S. is making a ton of money just issuing 6 month T-bills at .11

I go after shadow stats a decent amount because he claims that old measures of inflation would show we have 10% plus inflation. But if we have 10% plus inflation, that means the U.S. government is actually making about 10% on its T-Bills, because T-Bill rates are almost zero.

Inflation in energy has horrible consequences - I am not denying that. But I don't blame speculation on the fed. I don't know how you might finance your trading margins, but most professionals use T-Bills, not cash. Forcing people into cash - like the fed is supposedly doing - should actually reduce speculation, because the vehicle most professionals use to fund speculation is not cash, but T-Bills.

Anyway, enjoy your work - and thanks for sharing your thoughts on so many topics!



Posted by: TC | June 16, 2011 at 09:46 AM

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June 01, 2011

Should we even read the monthly inflation report? Maybe not. Then again...

In a recent issue of Economic Synopsis, our colleague Dan Thornton of the St. Louis Fed questions the usefulness of the traditional core inflation statistics—the consumer price index (CPI), or the personal consumption expenditure price index that strips out food and energy costs. Specifically, Dan asks whether the core inflation statistic is a better predictor of future inflation over the medium term (say, the next two or three years), than the headline inflation statistic. His conclusion is that:

"[F]or the most recent period, there is no compelling evidence that core inflation is a better predictor of future headline inflation over the medium term."

But Dan also invites the following:

"[I]n the interest of greater transparency and to allow the public to better understand its focus on core measures, the FOMC [Federal Open Market Committee] should provide evidence of the superior forecasting performance of the core measure it uses."

Well, of course neither writer of this blog post is on the FOMC, and equally obvious is the fact that we don't speak for anyone who is. Moreover, we're not very big fans of the traditional core measures, and we much prefer trimmed-mean estimators of inflation when thinking about recent price behavior.

Nevertheless, we'd like to attempt an answer to Dan's call, even if it wasn't aimed at us.

Here's the experiment run by Dan: He used the past 36-month trend in the traditional core inflation measure and the ordinary headline inflation measure and tested which one most accurately predicted the next 36 months of headline inflation. He found that they're about the same. A similar look at 24-month trends yielded a similar result.

The upshot of these experiments can be seen in the figure below (which is a figure of our construction, not his).

The chart shows how accurately we can predict headline CPI inflation over the next three years using only headline CPI price data or, alternatively, using only core CPI price data. The essence of the conclusion reached in the Economic Synopsis is summarized within the shaded box. The forecast accuracy of the two- and three-year trends of the core CPI price measure doesn't seem to be a significant improvement to the plain-vanilla headline CPI.

But we wonder whether the contribution of the core inflation statistic is being accurately reflected in this experiment. For us, the power of a core inflation measure—whether it be the traditional ex-food and energy measure, or some more statistical construct like the trimmed-mean estimators—can't be seen by comparing data trends of this sort. The volatility of an inflation statistic, what we would characterize as "noise," dissipates rather quickly, generally within a few months (although for food and energy, it could play out over a longer period of time, we understand).

At issue is how much the most recent month's or quarter's inflation data should inform one's thinking about the future path of inflation. Implicit in the experiments reported above is that they shouldn't—well, only as much as the most recent monthly or quarterly data influence the trend of the past two or three years.

It may be that the most recent monthly or even quarterly data are so noisy that they have nothing useful to contribute to our perception of the future inflation trend. But then again, an experiment that assumes there is no useful information in the most recent inflation data does not necessarily make it so.

We'd like to call your attention to the remainder of the figure above, where we ask the question, what happens if you try to predict headline CPI inflation over the next three years using only the most recent price data? For example, what if we restrict ourselves to looking only at the most recent month's CPI report? What we see is that the core inflation statistic provides a much improved prediction of the future inflation trend compared to the headline measure. Specifically, forecast accuracy is improved by nearly 50 percent if you use the core inflation measure. (For you wonks, the root mean square error, or RMSE, of the core CPI prediction is about 1.4 percent, compared with a RMSE of 2.7 percent for headline CPI inflation.)

Now consider the behavior of CPI prices over the past three months. How informative of the future inflation trend are these prices? Well, the accuracy of the headline inflation statistic improves relative to the one-month percent change because averaging the data over time in this way necessarily reduces the transitory fluctuations in the data. But again, the three-month core CPI price statistic provides a much better prediction of future headline inflation than does the three-month trend in the ordinary CPI statistic. In other words, if you're wondering what the past-three months of data tell you about developing inflation pressure, you're much better off considering the core statistic than you are the headline number.

Here's another observation we'd like to make: The most recent three-month trend in the core CPI inflation measure appears to be a more accurate predictor of future inflation than the 12-month headline CPI trend. Moreover, the three-month trend in the core measure is roughly as accurate as its longer-term trends. This observation suggests that paying attention to the core measure may allow you to spot changes in the inflation trend much more quickly than using headline alone.

Again, to be clear, we aren't endorsing the core inflation statistic. We're fans of trimmed-mean estimators and think they do an even better job of informing thinking about what the most recent price data tell us about the likely future path of inflation. (As evidence, we included in the chart above the same forecasting results for the median CPI.) We only want to make one simple point—the usefulness of a core inflation measure is best seen in the monthly and quarterly intervals that span FOMC meetings, not in the two- or three-year trends which are, by construction, largely silent about the most recent data.

By Mike Bryan, a vice president in research at the Federal Reserve Bank of Atlanta, and Brent Meyer, a senior economic analyst at the Federal Reserve Bank of Cleveland


June 1, 2011 in Forecasts, Inflation | Permalink


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You can't test whether core is useful this way. For example, if a central bank is targeting 2% total inflation at a 2-year horizon, and if it is doing it right, then *nothing* should forecast 2-year ahead inflation. This is an immediate implication of rational expectations on the part of the bank. Deviations of total inflation from 2% are the bank's forecast error, which should be uncorrelated with anything in the bank's information set 2 years prior.

More in my post here: http://worthwhile.typepad.com/worthwhile_canadian_initi/2011/06/no-you-cant-test-whether-core-is-useful-that-way.html

Posted by: Nick Rowe | June 02, 2011 at 07:31 AM

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