Sticky inflation vs Flexible inflation (the Cleveland Fed)

[ThePythonicCow]

The Cleveland Fed has another take on the Great Inflation Debate. We've seen elsewhere a distinction between what you need (e.g. food and gas, inflation expected) and what you want or what you borrow to purchase (e.g. real estate and cars, inflation less obvious.)

Now the Cleveland Fed distinguishes between volatile priced items (they call these "flexible") and stable priced items (they call these "sticky".) Flexible items include gas at the pump and fresh fruit at the grocery. Sticky items include rent and garbage collection.

They have some persuasive data and analysis, and some interesting results. From their synopsis:

Some of the items that make up the Consumer Price Index change prices frequently, while others are slow to change. We explore whether these two sets of prices—sticky and flexible—provide insight on different aspects of the inflation process. We find that sticky prices appear to incorporate expectations about future inflation to a greater degree than prices that change on a frequent basis, while flexible prices respond more powerfully to economic conditions—economic slack. Importantly, our sticky-price measure seems to contain a component of inflation expectations, and that component may be useful when trying to gauge where inflation is heading.

You can find this Commentary at Are Some Prices in the CPI More Forward Looking Than Others? We Think So.

In short, the "sticky" items are (a) a good predictor of CPI, and (b) show continued "disinflation" (inflation down to 1.8 per-cent as of March 2010.)

Note that this commentary was published in May 2010.

(A tip of the hat to "Guest author" in a post at Barry Ritholtz's site.)

[FRED]

Re: Sticky inflation vs Flexible inflation (the Cleveland Fed)

The Cleveland Fed has another take on the Great Inflation Debate. We've seen elsewhere a distinction between what you need (e.g. food and gas, inflation expected) and what you want or what you borrow to purchase (e.g. real estate and cars, inflation less obvious.)

Now the Cleveland Fed distinguishes between volatile priced items (they call these "flexible") and stable priced items (they call these "sticky".) Flexible items include gas at the pump and fresh fruit at the grocery. Sticky items include rent and garbage collection.

They have some persuasive data and analysis, and some interesting results. From their synopsis:
You can find this Commentary at Are Some Prices in the CPI More Forward Looking Than Others? We Think So.

In short, the "sticky" items are (a) a good predictor of CPI, and (b) show continued "disinflation" (inflation down to 1.8 per-cent as of March 2010.)

Note that this commentary was published in May 2010.

(A tip of the hat to "Guest author" in a post at Barry Ritholtz's site.)

Barry has been on the deflation bandwagon with Mish since early 2007. After the deflation spiral they'd argued for years failed to materialize, they adopted a new position: a prolonged period of low inflation.

Our position since 1998 is that the economy will go through a series of periods of asset price inflation and deflation popularly known as bubbles. Central bank policy, sans gold standard, will prevent the disinflation periods from turning into deflation spirals. Specifically, dollar depreciation will be used to send inflation into the economy via high energy import prices.

The result will be higher prices and lower aggregate demand. In late 2008 we forecast that inflation as declining purchasing power will appear in the form of lower product quality and quality for the same nominal price. The evidence is overwhelming that this has in fact occurred.

The BLS and Fed are happy to report that no major nominal increases in prices is occurring, but it's disappointing that Barry and Mish can't see through this; purchasing power is being lost as a result of the policy response to the collapse of the housing bubble, and this tax on savings and income comes on top of 30 years of inflation taxes exacted by FIRE Economy since the 1980s.

Starting in 2007 (e.g., Funhouse Mirrors) we explained that the American experience of inflation as measured via PCE (what you actually spend) versus CPI (what the government says things cost) is the aggregate of declining traded goods prices in the Productive Economy due to outsourcing of production to low wage countries (appliances and clothing), rapidly rising non-traded goods and services prices in the FIRE Economy (housing, education, and medical care) inflated by the application of credit to purchases previously made with cash, and spiking energy prices from imports (65% of oil) due to lack of a viable energy policy.

Energy prices have risen continuously, although in a choppy fashion, since 2001. To call a nine year rise in energy prices "volatile" is, in our view, dishonest.

This change in the composition of PCE coincided with the dismantling of the Productive Economy and growth of the FIRE Economy. This theory of a fundamental change in the American political economy in the early 1980s, and its impact on prices and purchasing power, has been highly predictive. The Fed's arguments about "sticky and non-sticky" prices today is roughly equivalent to the Fed's arguments in 2006 about the benefits of sub-prime mortgages to society: politically motivated crap. Why Barry and Mish spend a minute listening to the latest sales pitch from the Fed is a mystery to us.

[c1ue]

Re: Sticky inflation vs Flexible inflation (the Cleveland Fed)

Why Barry and Mish spend a minute listening to the latest sales pitch from the Fed is a mystery to us.

To a hammer, every problem is a nail.

To a deflationist...

[ThePythonicCow]

Re: Sticky inflation vs Flexible inflation (the Cleveland Fed)

To call a nine year rise in energy prices "volatile" is, in our view, dishonest.

Well, energy prices do have a higher variance (standard deviation squared, ) than rent or garbage collection fees.

So far as I can tell, some things have been trending up, some down, and some neither. Some things are more volatile, some more stable. Some of these trends will continue, some not.

There clearly have been serial bubbles and there clearly have been some rather substantial reallocations and misallocations of resources.

A forecasters task is to identify the trends that have been happening, those that will continue, those that will reverse, and the new trends that will emerge.

Chronic slandering (labeling their observations "dishonest" "crap") of those who focus (too much in your reasonable view) on some trends over some others is not helpful in my view. It neither leads to greater insight of ones own, nor to greater persuasiveness of the presentation of ones insights to others.

Rather I would suggest acknowledging the facts of the matter that others might highlight (I would have to agree with Mish, Barry and the Cleveland Fed that my petro bill is more volatile than my rent bill), but then focusing on the "more interesting" facts that better illuminate the emerging trends that might best guide us in the future.

The stance I would suggest sounds more like "Yes, those facts are to some degree valid, however these other facts are also true enough and better illuminate the continuing, reversing and emerging trends that should dominate our planning."

The question is not whether prices are inflating or deflating. Examples can be found of both, as you have shown us.

The question is what trends have been, and more interesting, will be, happening.

We humans have a tendency to jump from the presentation of the evidence to the anticipated conclusion. We shout "out of order" when evidence is presented that we fully and reasonably anticipate will be used to bolster conclusions with which we disagree. Such evident irritation suggests some rigidity of thinking, some blind spot, some denial. Something is still "other", evoking a hostile or immune response.

Blind spots give birth to black swans.

[ThePythonicCow]

Re: Sticky inflation vs Flexible inflation (the Cleveland Fed)

Importantly, our sticky-price measure seems to contain a component of inflation expectations, and that component may be useful when trying to gauge where inflation is heading.

One criticism of this I would level: The Cleveland Fed uses "CPI" as a proxy for inflation, and judges their "sticky-price measure" as useful for anticipating inflation trends because that measure correlates better with future CPI than "the expectations-augmented Phillips curve" (whatever that is -- don't ask me.)

However, given what they choose to include in the CPI (stable items that aren't rising rapidly, it seems) it should not be surprising that their "sticky-price measure" (relatively stable items) is a decent predictor of CPI.

Correlations observed between two measures suffering from similar selection biases have dubious significance.