Friday, August 08, 2008

Alan Reynolds & Inflation

In a post on the Cato Institute blog, "Cato @ Liberty", Alan Reynolds refers to my post on the apparent disagreement between him and his fellow Cato fellow Steve Hanke on the issue of inflation. He apparently thinks I mischaracterized his views as he comments my formulation that he doesn't think inflation is a problem with "huh?".

(BTW, Alan, my last name is spelled with just 2 "s". Not that I don't find it interesting to see this error as people who misspell it usually make the opposite mistake and insert only one "s")

I'll again link to the original article
and let readers decide what the reasonable interpretation of it is. Personally I have some difficulty seeing how an article entitled "Why Not to Panic on Inflation" with matching text should not be interpreted as saying that inflation isn't really a problem, or at least not a significant one. And the point of that post was simply to note his views and contrast those with Hanke's, not really to discuss the accuracy of those views.

But now that we're on that subject, let me note first of all that he is somewhat unclear in his text as to whether he thinks that all-items inflation shouldn't be seen as a form of inflation or whether he simply thinks it lacks predictive power over future inflation. And similarly, whether ex-energy inflation should be seen as the true form of inflation or whether it should be seen as a leading indicator for inflation. And that is not the same thing. Yet while he mostly discusses the issue in terms of what the best leading indicator is, he also writes "The price of oil fell this February, for instance, and that month’s CPI was unchanged - zero. Did that mean inflation was zero? Of course not." which clearly means that all-items CPI isn't inflation.

As for the leading indicator issue, we all know that energy prices are volatile and it should therefore not be surprising that they often fall back after periods of dramatic increases (which . However, as I noted in this post, since 2000 significant movements in all-items inflation have tended to precede movements in "core" inflation (ex food and energy) while on the other hand movements in "core" inflation have if anything a negative relationship with all-items inflation.

And when it comes to comparisons with past periods of inflation, that is to a large extent a comparison of apples and oranges as today's CPI isn't calculated using the same methodology as before, as a number of methodological changes designed to lower the reported rate of inflation have been introduced all of which lowers currently reported inflation. However, these changes did not result in any revision of previous numbers, making it misleading to compare the numbers. Using the old methodology, inflation, especially ex-energy inflation, would be a lot higher. Or alternatively, using the new methodology inflation in the 1970s would have been a lot lower. That means that regardless to what extent you think these changes were justified, the numbers are to a large extent incomparable.


Blogger Alan Reynolds said...

You believe I was "somewhat unclear in his text as to whether he thinks that all-items inflation shouldn't be seen as a form of inflation or whether he simply thinks it lacks predictive power over future inflation."

I think I was perfectly clear that I meant the latter, which is also true of the three Fed studies I linked in my blog.

The headline CPI is lousy predictor of the headline CPI, but the ex-energy CPI works pretty well. The math is unavoidable -- to keep year-to-year CPI at 5% which ex-energy CPI below 3%, we need to see oil keep rising very fast. As I wrote in June, oil at $145 had no place to go but down.

In case anyone wondered, I'm not just short oil and gold but long the dollar too (an exchange traded fund called UUP). I don't say one thing and invest in opposite way. And I'm a very successful investor.

8:37 PM  
Blogger stefankarlsson said...

Well, if you started shorting oil in early July, that would have been successfull. But if you started shorting oil back in February when you in your column "The Fed Does Right" predicted oil would fall from the $90 level it stood at then, I think we all know successfull you would have been. Not to mention your call back in late 2006 for the dollar to fall when it stood at $1.30 per € or your assertion back in 2005 that oil would fall from its level of $50 while there was noway that house prices would fall....

And I can bet you right now that if you stay with those positions you will lose (BTW, oil was at $135 when you wrote your June article)

10:49 PM  

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