It’s not often that a member of the Federal Reserve’s inner circle ditches Fedspeak in favor of something more honest. Governor Christopher J. Waller did exactly that, in his speech titled: The Economic Outlook and a Cautionary Tale on “Idiosyncratic” Price Changes and Inflation, where the latest addition to the Fed’s Board talked about manipulation of (price) inflation data.
He raises some concerns:
Inflation has been running higher this year than I and most forecasters expected. It has not been high for just a month or two—it has been high all year.
Waller mentions the price of lumber and how it has “skyrocketed through May.” He also talks about how used car prices have increased substantially, and he now closely monitors housing services, such as rent. Eventually, he shares a kernel of truth:
As I mentioned earlier, a lot of commentators, including me, have deflected concerns about high inflation readings being the result of “outliers” or “idiosyncratic” price movements.
Lately, there have been many reports about how inflation rates are being skewed due to increases in lumber and used cars, which conveniently allowed overall price increases to be downplayed for some time, or worse, the idea that:
As a result, recent high inflation readings are transitory and not broad based. But there is a fallacy in doing so that one should avoid in judging whether higher inflation is indeed transitory.
He provides a simple example of some of the problems with inflation data; here are four highlights below:
Now, one could look at this data and manipulate it in several common ways.
First, if one used a trimmed-mean measure of inflation, you would throw out the highest and the lowest readings for each year.
While this may help in statistical modelling, the real-world doesn’t work this way. Unfortunately, if just one product or service that someone purchases has increased in value by an extraordinary amount, the individual can’t easily “throw out” the item from their expenditure due to its high value such as fuel for a car or gas for heating a home.
A second way of manipulating the data is to say in year 1, “Look, inflation is being driven by good A, which had an idiosyncratic, outsized price increase. If you throw it out, the underlying inflation rate is 2 percent.”
By “selectively throwing out unusually high price increases,” he explains how inflation data can be shaped to meet the goal of whomever is using the data.
Third, one can justify throwing out good A in the first year by saying it did not reflect a broad-based price increase…
Again, with enough rationale, there really is no limit on just how much data can be manipulated or discarded entirely.
Saving the most recognizable method until the end:
Finally, one could claim, correctly, that the large price increase for good A is “transitory”—it went up strikingly in year 1 but then dropped back, meaning inflation should fall back to our inflation target in coming periods. But that will mislead you in terms of understanding the true inflation rate, because you are putting zero probability that a large spike in inflation will happen to another good in the future.
Calculating inflation is problematic for countless reasons, but at least he noted several of them. Coming from a Governor at the Federal Reserve, it becomes almost praiseworthy, especially because Chair Jerome Powell has seldom, if ever, spoken this candidly about the methodology employed by the Fed. It’s refreshing that the new Governor noted some of these problems and came clean with his own candid opinions on how they’re trying to solve them.
But before applauding Waller, don’t forget, he’s a central banker at heart, therefore some Fedspeak is warranted:
…I continue to believe that the escalation of inflation will be transitory and that inflation will move back toward our 2 percent target next year. That said, I am still greatly concerned about the upside risk that elevated inflation will not prove temporary.
Still, the insight has been appreciated. The problem is not the statistical technique or the calculation itself, rather, it’s that these techniques are then used to make real world decisions, often devoid of economic theory or consideration for any semblance of reality.