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Global cc: On a Note About Inflation Confusions

I haven't written in a couple of weeks - a combination of quiet markets, and a lack of intersection between stuff that's interesting to write about and my having time to write - but I thought I would "global cc" everyone on something I just wrote in a private email about some common misconceptions regarding the CPI:

A friend and longtime reader (name withheld) writes:

Mike,

I thought you might find these interesting....
davidstockmanscontracorner.com/memo-to-d...
davidstockmanscontracorner.com/inside-th...

My response is below:

Thanks. Unfortunately Stockman doesn't understand what he's talking about. He understands better than most, but then he starts saying how the BLS asks homeowners what their homes would rent for...which they do, but only to determine weights, every couple of years, not to determine OER. It says this very clear in a paper on the BLS website called "Treatment of Owner-Occupied Housing in the CPI:"

"To obtain the expenditure weights for the market basket...Homeowners are asked the often-cited question:

If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished and without utilities?

This is the only place where the answers to this question is used; in determining the share of the market basket. We do not use this question in measuring the change in the price of shelter services."

For that purpose - calculating inflation itself - a survey of actual rents is used. I can understand how the casual observer doesn't 'get' this, but there's no excuse for Stockman not to know, especially if he is railing about the CPI...he should take some time to understand its main piece.

In short, Stockman writes a good populist screed, but he avoids the main questions:

1. Is headline inflation a better predictor of future inflation than core inflation? Answer: No, even if we can now realize that the rise in energy prices was a permanent feature of the decade ended in 2010, it tells us exactly nothing about whether those are likely to persist. The Fed uses core CPI not because they don't think people use cars (whenever a columnist uses that silly argument, I know they're just writing to please a certain audience), but because core CPI is persistent statistically in a way that headline is not. In fact, some Fed statisticians prefer median, or trimmed-mean, neither of which proscribes any particular category. So whining about how the Fed doesn't include the particular brand of inflation that concerns you misunderstands how and why policymakers actually use measures of inflation in policymaking.

2. Suppose the CPI represents a miserable mis-estimation of actual inflation. Then, pray tell, why does a trillion-dollar market based on that index get priced as if it is accurate? In Argentina, where the inflation numbers are made up, the inflation-linked bonds trade very cheap because they will pay off in a number that is assumed to be too low. And the bond yields are too high by roughly the amount that inflation is assumed to be understated in the future. Markets are efficient, especially big markets. How did the Fed manage to convince at least $1T in private money to misprice the bond market?

3. If the CPI is so wrong, so manipulated, then why to measures of inflation that the government has nothing to do with, like the Billion Prices Project, come up with the same number?

It's nice that Stockman has a following. And he's gotten the following partly by ranting about a number people love to hate. That gets him read, but it doesn't make him right.

 


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Enduring Investments is a registered investment adviser that specializes in solving inflation-related problems. Fill out the contact form at http://www.EnduringInvestments.com/contact and we will send you our latest Quarterly Inflation Outlook. And if you make sure to put your physical mailing address in the "comment" section of the contact form, we will also send you a copy of Michael Ashton's book "Maestro, My Ass!"

 

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