Does the Fed Write Songs for One Direction?
“One Direction says I’m beautiful because I don’t know I am! “I think I’d kiss Harry or Zayn if they were… Wait! I have to like, already be beautiful for me to not know I’m beautiful. So how can not knowing I’m beautiful make me? OMG, One Direction do you love me or not?!
(Presses furry stuffed pony into chest and flops on bed. The mattress gently bounces as sobbing ensues).
Alright, let’s cut to the Fed version: We’ll keep you posted on our management of inflation by using a theory that denies inflation.
Can the Fed control it? First they have to isolate it…
- The consumer price index uses “average income.” But the more unequal the distribution of income, the more the average gets shifted- a potentially faulty measure.
- The price of globally traded commodities used in domestic products will naturally affect prices of those domestic products. Very little can be done to control pricing on global commodities. Good luck Fed!
- Prices might be limited by short-term contracts. Again not much room to manipulate things, here.
You see, some argue that the Fed’s use of a neoclassical optic to view inflation, which, for example, states a proportional change in money equals a change in prices, doesn’t account for some real world factors. Along with 1-3 above, it assumes full employment and a constant velocity of money- -not too practical.
Key to the post is that not all Fed tools used to isolate inflation account for it. Like One Direction’s theory on beauty, You can’t theorize about something by using tools that deny that that “something” is there.
Portions borrowed from Neoclassical Inflation. No Theory There; John Weeks. Izmir Review of Social Sciences. Vol. 1, No 2, Jan. 2014. I recommend Weeks’ Book A Critique of Neoclassical Macroeconomics.
The opinions voiced in this material are for general information purposes only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial adviser prior to investing. Securities and advisory services offered through LPL Financial, a registered Investment Adviser. Member FINRA / SIPC
3 Responses to “Does the Fed Write Songs for One Direction?”
"The consumer price index uses “average income.” But the more unequal the distribution of income, the more the average gets shifted- a potentially faulty measure."
First of all, the Fed does not use the CPI to measure inflation, it uses the PCE deflator, which uses entirely different methodology. Second, I don't see how a change in income distribution affects the CPI–perhaps through the way weights are calculated? The effect could hardly be large, and mostly it would affect the level, not the rate of change (inflation)
"The price of globally traded commodities used in domestic products will naturally affect prices of those domestic products. Very little can be done to control pricing on global commodities. "
It is true that the US accounts for only a fraction (although a fairly large fraction) of demand for world commodities. However, it is misleading to say the Fed can't affect inflation because it can't affect commodity prices. What the Fed cannot (much) effect is the *real* price of commodities. However, if the Fed pursued inflationary monetary policy, standard theory suggests that real commodity prices would remain more or less unchanged, but nominal prices would rise (inflation) while the exchange rate fell at the same rate.
"Prices might be limited by short-term contracts. Again not much room to manipulate things, here. " True, short-term contracts make prices sticky, but the Fed's time horizon for its inflation policy is much longer than the duration of short-term contracts.
Ed, Thank you for taking time to add clarity to the article. I do seem to have spanked the Fed more heavily than it deserves. My point, if not clearly stated, was that many small factors can unite to create lesser control then those with lesser education than you on the matter might assume. To respond-
1. Though PCE is certainly a major contributor, it goes in hand with CPI and PPI to this end. As the Cleveland Fed points out “…For this reason, many measures of “core” inflation have been developed from the basic price indexes, such as the CPI excluding food and energy, the median CPI, or the core PCE.”
2. Regarding commodity prices: Your point is well taken. Thank you for it. Excuse me if you thought I implied that the Fed *cannot affect* inflation because it cannot affect commodities. I do imply (via the article) that the Fed has less of a grip on control because of this and the other factors.
3. Short term contracts: True, naturally the policy will be longer term. I think my point is simply less theoretical. I naturally think from a financial / investing market position in which a year can influence much.
Thanks for your insights, Dave!