• Markets
• Economy
• Federal Reserve
• Housing
• Energy
• Digital Media

QOTD: Bernanke on Inflation

Un-frickin-believable:

"Delivering a speech to the National Bureau of Economic Research, the Fed chief said "changes in energy [and food] prices should have relatively little influence on 'core' inflation, that is, inflation excluding the prices of food and energy."

(emphasis added)

There you have it -- straight from the Fed Chair's own mouth -- except for the items going up in price, there is no inflation!
>
~~~

UPDATE: July 11, 2007 8:31am

Peter E. Kretzmer, senior economist for Bank of America, explains (more or less) what the Fed means  by relating "inflation expectations" to the ability of the Fed to impact price rises (i.e., stability):

“This Fed much more so than prior Feds puts a very heavy emphasis on the role of inflationary expectations,” he said. “They believe, and research shows, that inflation expectations and the Fed’s inflation-fighting credibility has a large impact on private sector wage- and price-setting behavior.”

In other words, the Fed's emphasis on Core inflation -- jawboning, PR, propaganda, whatever -- is every bit as important to future prices as the actual underlying causes (excessive monetary creation, demand exceeding commodity supplies) of inflation.

I am not sure I buy that. Surely, psychology is important, and the collective expectations of either higher or lower prices can impact subsequent price behavior. 

But this approach puts the Fed into the role of a low price cheerleader, and runs the dangerous risk fo well, artificially emphasizing the irrelevant core rate of inflation rather than dealing with reality of the actual price increases as experienced by consumers.

Additionally, it means that all of the prior chatter about removing volatile food energy prices due to their erratic price behavior was quite simply bullshit. Based on yesterday's Bernanke speech, we learn that the emphasis on the Core rate of inflation is about influencing psychology and sentiment -- not smoothing out volatile data.

>

 

UPDATE 2: July 12, 2007 11:31am
Herb Greenberg mentions the latest comments from the CEO of Nestles:

Here's the article:

Nestle to cut plants, products as prices soar
Nestle, the world's largest food company, will raise prices, cull unprofitable products and speed up production rationalization to prepare for a lasting rise in commodity and energy prices.

Jose Lopez, management board member at the Swiss-based firm, told Reuters the group's focus on name-brands, health food, and medical nutrition puts it at a competitive advantage as prices for energy, grain and milk rise on surging demand.

Rising input prices globally will stoke inflation, which will enable Nestle -- maker of KitKat chocolates and Nespresso coffee -- to pass those costs on to consumers, Lopez said in his first interview as head of operations for the global giant.

"It could provoke moderate inflation and moderate inflation is not a bad environment for business," Lopez said in his first interview as head of operations for the global giant. "If anything, I can buy better because I am bigger."

>

Sources:
Wall Street gets smacked
Major gauges fall over 1 percent after series of earnings warnings, more subprime news; investors weigh Bernanke speech.
David Ellis
CNNMoney.com, July 10 2007: 5:50 PM EDT
http://money.cnn.com/2007/07/10/markets/markets_530/index.htm?postversion=2007071017

Fed Chairman’s Talk Further Dims Hope for a Rate Cut 
JEREMY W. PETERS
NYT, July 11, 2007
http://www.nytimes.com/2007/07/11/business/11fed.html

Wednesday, July 11, 2007 | 06:05 AM | Permalink | Comments (53) | TrackBack (2)
add to de.li.cious | digg this! | add to technorati | email this post

Comments

What I assume he means is that food and energy inflation has not yet pressured prices of items in the core CPI.

So its a bit less insane than it appears . . .

Posted by: Barry Ritholtz | Jul 11, 2007 6:11:32 AM

That's what he means. For example, higher energy prices push up the price of transport - what Bernanke is saying is that he expects this effect to be small.

Posted by: datacharmer | Jul 11, 2007 7:05:09 AM

Barry,

What Bernanke meant was, if inflation expectations are anchored (i.e. do not rise), then a ONE TIME increase in food or energy prices should have little influence on inflation.

How do we know if expectations are anchored? BB says look at: Wolverine Survey, TIPS spread, ISM prices paid. This in fact was the most telling part of his speech. He left out commodity prices as a measure of inflation expectations!

In other words, if commodity prices rise, its some freak supply demand thing. Nothing to do with money supply, real rates, the Fed, or inflation expectations.

The view that commodity prices are not a valid measure of inflation expectations is so blind as to be negligent.

Posted by: David Pearson | Jul 11, 2007 7:42:51 AM

What he is saying is that with the hedonic adjustments, geometric weighting, and substitution, it is possible to ignore inflation by using the core CPI.

Posted by: Winston Munn | Jul 11, 2007 7:49:58 AM

What he really meant is that the game is rigged and he's running the wheel. The ball always lands in the no inflation slot.

Posted by: john | Jul 11, 2007 8:22:21 AM

I like to start the day with a good laugh...

Posted by: babygal | Jul 11, 2007 8:28:28 AM

I LOVE substitution. I've gone from poached salmon to catfish fillets to fish sticks and now I'm eyeing tabby food. Same protein content. Why sould I bitch? At some point, the 'people' will go from i Macs to big Mac's to Mac 10's. Well you can always substitute uzi's for mac 10's.

Posted by: Ross | Jul 11, 2007 8:36:41 AM

In the last 3 paragraphs they insinuate that higher rates as a fix for inflation is "speculation" and needs some more "examining"...yeah...what a country...

Posted by: DD | Jul 11, 2007 8:49:14 AM

The Fed influences price-setting behavior in the private sector? Not likely. Outside of Wall Street, no one cares, nor pays the slightest attention to what the Fed says on any subject.

Posted by: RWS | Jul 11, 2007 9:00:56 AM

It's also to screw pensioners.

Posted by: Scytale | Jul 11, 2007 9:08:47 AM

It is so hard to keep myself from worrying that Ross is the most prescient of us. . .

Posted by: XON | Jul 11, 2007 9:10:24 AM

and the dollar loves all this news...

Posted by: DD | Jul 11, 2007 9:10:58 AM

I actually don't object to the removal of energy and food from the equation, as these items respond to true laws of supply and demand rather than artificial, debt-created demand.

However, it seems to me that with geometric weighting, hedonic adjustments, and particularly substitution, what the Fed is trying to guage with core inflation is not inflation at all, but the country's ability to consume.

Posted by: Winston Munn | Jul 11, 2007 9:11:24 AM

Ben is just trying to make it look like he has bigger balls in this game than he really does. We all know he doesn't anymore.

China, Russia, and all the other owners of our t-notes have our collective balls in a jar. It's up to them now. Paulson and Gentle Ben better go pick out some pretty lipstick.

Posted by: Kp | Jul 11, 2007 9:15:52 AM

We've heard about your dissatisfaction with Core CPI a thousand times, but I don't think we've heard:

1) Is Core CPI still a useful measure of anything, or would you cease to report it entirely?

2) Is there some other adjusted measure you would substitute for it?

3) Anecdotes about New York real estate aside, what is your (non-technical) definition of inflation?

What I think we're seeing is the beginning of an era of two countervailing trends. Prices of anything subject to productivity gains (e.g., via IT or reduced labor inputs) will contribute to DEFLATION, whereas anything asset-based (Barry's house, rooms at decent resorts, organic foods) will experience INFLATION. This begs the question: what constitutes a valid substitution in an age of abundance, and suggests there may be room for a metric like the old Cost of Living Well.

Posted by: John F. | Jul 11, 2007 9:16:45 AM

What I got from the speech is that inflation expectations are the most important factor or risk of inflation than actual inflation. Did I say that right?

I got the feeling that the measurment of inflation is still being examined, that the fed is still learning which metrics to weight more heavily, but that the psychology of fighting inflation is just as important as the action of rising rates to fight inflation.

In other words, if expectations are that inflation is rampant and out of control, corporate/private sector behavior will adjust and that in itself will aggravate the problem of inflatiion.

Did anyone else hear it like this?

PS: I especially like that first question which obviously was from a woman like 110 years old. Longest question ever! Even Big Ben wanted to start rolling his eyes.

Posted by: UrbanDigs | Jul 11, 2007 9:18:05 AM

XON -

There will be no cat food...it is imported...and yeah...there will be no more of that...

Posted by: DD | Jul 11, 2007 9:27:39 AM

I still don't understand why you are so upset with the Fed. Food and energy prices have gone up, not much else has. Is this because the Fed is printing too much money? And if so, do you think that the FOMC should raise the federal funds rate? If not, why are you so focused on "core" inflation?

~~~
BR: Not much else has gone up? Medical costs (+15%!), Education, Insurance, Home prices (still way over the inflation rate for the past 5 years), Professional Services (docs, lawyers accountants), and Restaurants.

Cheaper: iPods, plasma screens, (and apparently, hashish).

Posted by: Andy | Jul 11, 2007 9:30:19 AM

Am I the only one who flashed to the scene from the Wizard of OZ...

"Ignore that man behind the curtain!"

Posted by: Linda P. | Jul 11, 2007 9:33:58 AM

" then a ONE TIME increase in food or energy prices should have little influence on inflation."

I for one expect gasoline to higher each fill up, and each trip to the grocer to have higher prices. I don't know what cave this guy is living in.

So what will be the excuses when gasoline is $4 a gallon? The head of Nestle's said that ag inflation is going to cause food prices to rise the next 5 years. That is what I expect.

Posted by: me | Jul 11, 2007 9:35:02 AM

It is about manipulating data to create the appearance of controlled inflation while at the same time keeping Wall Street in a fat pool of cheap easy money.

Posted by: spongetoddsquarepants | Jul 11, 2007 9:37:28 AM

It's what I've been saying for the past year. The only way for the US to fix its current economic problems without a depression are to have moderately high inflation while maintaining low inflation expectations. It's a way to cut real interest rates so that the debt load is manageable. It works wonderfully as long as you can convince your lenders that inflation is low. Once they stop believing you, it's likely to blow up badly.

jkw

Posted by: jkw | Jul 11, 2007 9:51:21 AM

"Fed’s inflation-fighting credibility"

oxymoron of the year....

They have credibility??? I for one see them losing whatever shred they had left with the what you worry statement.

"we;re not worried about it so you don't worry about it or we'll have to show that we will continue to talk about it but it's not something to worry about so don't worry....OK?

Got that?

Ciao
MS

Posted by: michael schumacher | Jul 11, 2007 9:53:12 AM

BTW I also think that article by Peters sort of sums up what is really wrong with expectations....rate cuts??? what planet is he living on? obviously the one where Ben and Hank live on where nothing matters other than the price of Goldman Sachs and canandian bonds.

Ciao
MS

Posted by: michael schumacher | Jul 11, 2007 9:57:49 AM

Barry,

I think you're a bit off track here.

Bernanke and company are not saying that the price level or inflation is determined by solely by expectations.

We all except that in the long-run the average price level is determined by the quantity of money.

The question is what happens in the short run. What happens when the FED actually changes its rate target, etc.

If the FED has little credibility and if people expect inflation to persist then the FED has to hit them over the head with a recession to change their minds.

In other words a low credibility FED is forced into the trap of overshooting, what it wants.

On the other hand a high credibility FED simply has to say: We will not cut rates until inflation goes down. People will believe the FED and they will start to change their pricing behavior in response.

On the issue of Food and Energy. If you believe that food and energy prices are being driven up by soft monetary policy and not supply side shifts then are you willing to make the following bet.

If the Funds rate does not rise above X over the next 5 years then the price of food and energy will continue to grow at at least Y.

Posted by: Karl Smith | Jul 11, 2007 9:58:43 AM

December 2008

Sun	Mon	Tue	Wed	Thu	Fri	Sat
	1	2	3	4	5	6
7	8	9	10	11	12	13
14	15	16	17	18	19	20
21	22	23	24	25	26	27
28	29	30	31