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Sunday, September 7, 2008

Moon-Bayers' Paranoia and How the US Government Tracks Inflation

Today's Topic: How the US Government Tracks Inflationary Pressures 

The debate about how the US government BLS (Bureau of Labor Statistics) --- filled with hard-working, unusually competent professional economists and statisticians, tracks various kinds of price movements in the US --- continues to flare on some very good economic sites on the Web . . . the economists themselves almost always, and rightly, defending the use of BLS indexes and lots of non-economists or non-statisticians or just plain uninformed people attacking the CPI and its varieties that the BLS publishes monthly. Lots of these uninformed people are also prone to extravagant conspiratorial theories.  


Two-Kinds of Moon-Baying Paranoia

For left-wing radicals, the US government and its agencies are in the pockets of big corporations and banks and can't be trusted to do anything sound or publish any non-ideologically informed statistical indexes: GDP, per capita income, the Gross Domestic Product deflator (to get "real" GDP growth once overall price increases are subtracted from nominal GDP), the CPI (the consumer price index, which tracks over 250 important components of average household purchases, the components weighted for importance and in terms of budget constraints for households), core CPI --- which, unlike the CPI (really, the CPI-U as it's called) --- excludes food and energy prices as too volatile to guide the Federal Reserve's decisions about interest rates, and so on. Remember in this connection: if the Fed had looked only at CPI-U --- which does include volatile price movement in food and energy --- it might have panicked in the late spring, fearing that a 30% increase in oil price between early April and mid-July was setting off a new inflationary binge that had to be combated by higher interest rates. In the process, higher interest rates would have almost certainly sent unemployment surging and driven the US economy into serious recession. As it turned out, the Fed didn't raise rates, and its judgment was sound. Oil prices started plunging in late July and have almost fallen back by the same 30% as of Friday.

The second kind of radical paranoids are almost always zealous libertarians, followers of Ayn Rand, the novelist --- Atlas Shrugged, full of one-dimensional characters, heavy-handed dialogue, an implausible plot, and didactic homilies --- who is considered by them not just a great novelist ignored for conspiratorial reasons by pro-government literary critics, but also a great and original philosopher . . . ignored by 99.99% of all philosophers around the world for similar reasons. Conspiracies everywhere, you see . . . with the government of the US and all other democratic capitalist countries the enemies of freedom and economic efficiency as concocted in the writings of a handful of free-market economists --- usually dead Austrian economists hardly referred to by 95% of the profession here or in Europe, but along with Rand the greatest thinkers in the 20th century.  

Note quickly: it's not just the US government that is the enemy of all true-believing libertarians. Government in Canada, West Europe, Australia, Canada, Israel, and Japan are even worse, you see --- statist aggrandizers, out to smash both the little guy and the big rich guy (the latter the savior of the little guy, if given free reign in economic life) for selfish political and bureaucratic reasons.


The Result of Such Paranoia? 

Tersely put, it preys on the lack of economic knowledge of the average person, worried about rising energy and food prices, job security, stagnant wages since 2000 --- the only time in US history that wages have not grown in the boom phase of the business cycle's upswing (6 years between October 2001 and October 2007) --- and growing and justified worries about energy and food prices, job security, mortgage payments, and health-care costs.  

A Clear Example

Consider this recent example by way of illustration. The BEA, the Commerce Department’s Bureau of Economic Analysis that tracks our GDP and uses what’s called the GDP-deflator to subtract price rises from nominal GDP to arrive at real GDP growth --- positive or negative --- found in its first official report that real GDP had grown 3.3% in the second quarter of this year. How was that possible, especially at a time of rapidly rising energy and food prices? Well, the BEA had found that it had originally under-estimated in its preliminary report of late July the big growth in US exports, which have been growing at a phenomenal 15-20% average yearly rate since 2004. Additionally, though, the BEA found that the GDP-deflator --- used to subtract price rises from nominal GDP to arrive at real GDP growth (positive or negative) --- found that the deflator, which uses some complex chain-linked indexing of thousands and thousands of prices, had incorporated a 1.2% inflationary rise for that quarter.  

That astounded lots of people, even some analysts. But you see, the GDP price-deflator tracks only the prices of domestically produced goods and services. It is not the same as the CPI (U) , which tracks the prices of all consumer goods, whether or not (like oil or some good) they include the prices of imported goods.

More specifically, because of the way GDP --- remember Gross DOMESTIC Product --- is calculated, the costs of imported goods do show up in domestic Consumption, domestic Investment, and domestic Governmental purchases of goods bought in the US, but the overall prices of Imported Goods are subtracted from GDP-price rises exactly in the same way GDP reflects these components:

Y (GDP) = C + I + G (minus taxes) + X-I . . . where X means Exports and I means Imports

 In short, there is no sleight of hand, no effort to con the public --- only a consistent use of a deflator that is not the same thing as the CPI, never mind several other indexes that the BLS uses to track inflation. The GDP-deflator, to underscore the point, is not intended to equal the inflationary rate per se, and it is not therefore representative necessarily of what the average household faces in trying to make ends meet each day, week, or month in the face of price rises of certain key goods and services.


Today’s Buggy Topic Deals with the Paranoia about the BLS’s CPI-Index

Though the issue is partly technical, radical left-wingers and right-wing libertarian zealots are convinced that the index –- there are actually several CPI ones, though the headline one published monthly is CPI-U (urban household prices) --- has been changed since the Boskin Commission’s report of the mid-1990s that urged the BLS to incorporate three main changes:

*For price changes in the cost of housing, substitute a different price index . . . what’s called the equivalent rental change, which means the value of what the house would rent for if the owners moved out and rented to someone. That change --- which reflects the fact that 69% of Americans own their residents (or paying mortgages on them) and virtually all are not looking to buy a new residence --- goes back to 1981, and was simply updated in its calculations once the Boskin Commission reported in 1995.

*Apply simple micro-economic logic and have the CPI indexes take into account “substitution” effects: to wit, when the price of a good rises, most consumers will try to buy close substitutes that have not risen in price or even fallen. The paranoid left and right think that this means the BLS decides to substitute hamburger as the consumer-choice if the price of steak rises. That is not the case. It will look at steaks, and if it finds that in Chicago, say --- if the price of fillet mignon rises 20% in a month --- grocery shoppers in Chicago will tend to purchase cheaper tri-tip or flank steak.  

*And, taking into account all the quality changes that have occurred in computers, autos, cell phones and the like in recent times, these quality changes should be considered as a partial offset for the rise in the prices of those goods (if that has occurred).

There have also been a couple of other changes in the BLS, recommended by the Boskin Commission:

*Use a chain-linked way to track price changes, which means constant updating of the prices of consumer household items, rather than a fixed base-index several years old that used to be updated only 7 to 10 years or so.

*And weigh the prices of discount stores more heavily than the BLS used to before 1995, especially with their rapid spread in the 1980s and 1990s


Specifically Today, Prof Bug

 . . . joins some discussions of a just published document by the BLS, a remarkably clear, to-the-point refutations of the moonbat charges that flourish on the Internet. Short and concise --- just 17 pages or so --- the document also is always illuminating, thanks especially to the repeated use of simple illustrative examples by the two BLS writers.

For prof bug’s long comments, click here first --- a link to the discussion at Carpe Diem, a very good libertarian economic site run by Professor Mark Perry of the University of Michigan. Then, a much longer thread --- full of conspiratorial hokum left by most posters --- click here. It’s a link to EconBrowser, run by two gifted macroeconomists, one at UC San Diego and the other at the University of Wisconsin.