Barry Ritholtz at the Big Picture Blog asks “Why Has Inflation Remained Low for So Long?”

Ritholtz’s article is a guest post by author Robert G. King titled “Inflation in the Great Recession and Gradual Recovery: Surprises and Puzzles“.

Neither Ritholtz nor King ever answers the question. Instead, King presents mathematical gibberish regarding the Phillips curve coupled with visions of inflation dynamics, a new Keynesian model, and a long-term expectations model.

Inflation Dynamics


New Keynesian Model


Long-Term Expectations


King notes that all three models failed to produce the expected results.

Three Misses

All three models miss on features of the quarter-to-quarter inflation dynamics:

  1. The dramatic decline in inflation in late 2008 and early 2009
  2. The return to inflation averaging about 2% centered on 2011
  3. The low rates of inflation beginning in 2014 and ownwards

King presents 24 pages of even more complicated gibberish followed by another 20 pages of charts references and other essentially unintelligible items.

He concludes “It would be useful for academics working on micro pricing to help BLS create new pricing research series, both in terms of the design and potentially in terms of development of algorithms that the BLS could simply make use of each month.”

Truly Useful Proposal

If King wanted to propose something truly useful, he would have proposed economists stop the economic nonsense.

Attempts to predict consumer behavior via mathematical plug-in equations with dozens of assumptions, that fail to consider asset bubbles, debt dynamics, and globalization pressures is beyond foolish.

It’s amazing these models are even in the ballpark, which of course presumes reported inflation is indeed in the ballpark.

When the BLS tells us medical expenses are up only 5% from last year (more in this in a subsequent post), we know upfront, without a shadow of a doubt, the medical CPI component is vastly understated.

Moreover, the BLS’ models do not consider rising housing prices as part of inflation. That is the same mistake the Fed made from 2003-2007 hiking rates too little in the face of massively rising inflation.

Dissecting the Fed-Sponsored Housing Bubble; HPI-CPI Revisited

I touched on the subject of housing CPI on numerous occasions. Let’s take a flashback look at my 2013 article Dissecting the Fed-Sponsored Housing Bubble; HPI-CPI Revisited; Real Housing Prices; Price Inflation Higher than Fed Admits.

Comparative Growth in HPI vs. OER

From 1994 until 1999 there was little difference in the rate of change of rent vs. housing prices. That changed in 2000 with the crash and accelerated when Greenspan started cutting rates.

The bubble is clearly visible but neither the Greenspan nor the Bernanke Fed spotted it. The Fed was more concerned with rents as a measure of inflation rather than speculative housing prices.

Fed Funds Rate vs. CPI and HPI-CPI

The above chart shows the effect when housing prices replace OER in the CPI.  In mid-2004, the CPI was 3.27%, the HPI-CPI was 5.93% and the Fed Funds Rate was a mere 1%. By my preferred measure of price inflation, real interest rates were -4.93%. Speculation in the housing bubble was rampant.

In mid-2008 when everyone was concerned about “inflation” because oil prices had soared over $140, I suggested record low interest rates across the entire yield curve. At that time the CPI was close to 6% but the HPI-CPI was close to 0% (and plunging fast).

As measured by HPI-CPI real interest rates were positive from mid-2006 all the way to 2010, even when the Fed Funds rate crashed to .25%. That shows the power of the housing crash.

Real rates went positive again in mid-2010 until early 2011.

CPI and HPI-CPI Variance From Fed Funds Rate

The above chart shows the “Real” (inflation adjusted) Fed Funds Rate as measured by the Fed funds rate minus the CPI, and a second time by the Fed Funds Rate minus the HPI-CPI.

Alternate Question

Barry Ritholtz Asked “Why Has Inflation Remained Low for So Long?”

I ask “Is inflation low? For whom? By what realistic measure?”

King apparently believes the CPI accurately measures inflation. I propose it doesn’t. Medical CPI is a joke, and so is OER vs. housing prices. That’s for starters.

Shadowstats goes off the deep end in the other direction, with preposterously high measures of inflation.

Missing Factors and Poor Assumptions

King fails to take into consideration aging boomer dynamics, student debt, debt loads in general, asset bubbles, and all kinds of other pertinent variables.

Besides, there is no such thing as a standard consumer basket. Someone with kids in college has a far different basket than a retiree living on fixed income.

Fundamentally, it is difficult if not impossible to measure inflation in the first place.

There are all kinds of new gadgets, household items, etc. that did not exist even a few years ago.  To counteract, the BLS makes assumptions about quality improvements. The BLS also substitutes chicken for beef when calculating food CPI.

Let the Market Determine Rates

Standard measures of inflation fails to measure money supply, housing,  and asset bubbles. They do not need to be improved, they need to be discarded.

My own definition of inflation and deflation involves money supply and credit marked-to-market. The Fed ought to be worried about asset bubbles, not routine price deflation.

Given that the Fed has blown asset bubbles of increasing magnitude over time, the flaws and errors suggest we do something different.

I am confident there would not have been a housing bubble, at least of the magnitude we had, if there was a Fed that had not been holding interest rates too low, too long, on absurd notions that “inflation is low”.

The CPI system of measuring prices is a complete joke. Rather than attempting to improve it, I have a better idea, get rid of the Fed and let the market determine interest rates.

In a foolish attempt to defeat routine consumer price deflation, the Fed has sponsored yet another asset bubble that will bring about damaging asset bubble bust and credit deflation. The BIS would agree.

For discussion, please see Historical Perspective on CPI Deflations: How Damaging are They?

Mike “Mish” Shedlock