There is no such thing as “public opinion” (examples #233 and #234)

I occasionally post on how intellectuals tend to misuse public opinion surveys, often to argue that the public agrees with their policy preferences.  I do think there are a few questions the public is capable of responding to in a semi-coherent fashion, such as “should the death penalty be abolished.”  But when you get into the area of complex economic policy, then public opinion is just gibberish—it completely depends on how you frame the question.  This was triggered by a recent Ezra Klein post:

Policy hasn’t tracked public preferences very closely. In polls, Americans have clearly supported higher taxes on the rich and a much more punitive approach to banker compensation.

That’s one way of asking the question—should the filthy rich and evil bankers pay more?  But what if you ask the public what they consider to be the appropriate top income tax rate?

Three-quarters of likely voters believe the nation’s top earners should pay lower, not higher, tax rates, according to a new poll for The Hill.

The big majority opted for a lower tax bill when asked to choose specific rates; precisely 75 percent said the right level for top earners was 30 percent or below.

The current rate for top earners is 35 percent. Only 4 percent thought it was appropriate to take 40 percent, which is approximately the level that President Obama is seeking from January 2013 onward.

In another article I discovered:

Here’s how the numbers shake out:
— 21 percent of respondents recommend a rate below 20 percent;
— 17 percent recommend a rate of 20 percent;
— 23 percent recommend a 25 percent rate;
— 14 percent recommend a 30 percent rate;
— 13 percent recommend a 35 percent rate;
— 4 percent recommend a 40 percent rate;
— no one recommends a 45 percent rate.

No one!!!  Obama’s new tax bill calls for a top federal income tax rate of 43.4% in 2013, meaning the rich will face 50% tax rates in NY and California.  Krugman and Saez favor still higher rates.  I guess they weren’t asked.

Just to be clear, I’m not claiming the public agrees with me.  I think both my survey an Ezra’s survey are nonsense.  And one reason is that the public doesn’t understand taxes.  Actually, forget about the public, I’d estimate that half the economists I talk to don’t understand that taxes on capital are double taxing the same wage income.  That Buffett’s comment about paying 15% taxes is nonsense.  If every voter were as well informed as Matt Yglesias (who favors a progressive consumption tax, which would amount to about a 1% income tax on Buffett), then we could survey public opinion on tax and spending questions.

But right now?  Suppose you ask the public if spending $689 billion on the military is too much or too little.  Then ask them whether spending 4.1% of national income on the military is too much or too little.   Then ask them whether they believe we are currently spending too much or too little on the military.  Those who believe in “public opinion”  presumably believe there would be some sort of coherence to the answers to these three questions.    (BTW, I pulled these numbers out of the air—even I have no idea how much we spend.)

And the public’s numbers don’t even add up—they want pie in the sky and lower taxes and more government goodies.  If you simply sat them down and showed them the books they’d radically alter their policy views.

Pundits everywhere; can we please stop talking about public opinion on complex policy questions?

BTW, I don’t mean to pick on Ezra, who’s one of the best.  Everyone does this, I just happened to run across his link in an Arnold Kling post which contains this comment:

On a substantive point, I agree [with Tyler Cowen] that public opposition to inflationary monetary policy is a factor.  But is that anything new?  It seems to me that since the 1960s elite economists have been periodically saying that it would be better to live with higher inflation and the public has been saying, “No!”  The public opposition predates recent developments, either in terms of the recession or in terms of declining trust.]

The public has no idea what Bernanke means when he calls for higher inflation.  For Bernanke, that’s a code word for “higher real incomes for Americans.”  But the public sees inflation 100% in supply-side terms, as higher prices HOLDING MY INCOME FIXED.  In that environment it makes zero sense to talk about the public’s view of inflation.  Yes, they don’t like falling real incomes, but no one is proposing that.  We’ve averaged 1.1% inflation over the past 46 months.  Anybody think the public is enjoying those low inflation rates more than the 2-3% inflation of the Clinton years?

I thought not.


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155 Responses to “There is no such thing as “public opinion” (examples #233 and #234)”

  1. Gravatar of Ritwik Ritwik
    23. June 2012 at 16:29

    Now this is a post I agree with whole-heartedly.

  2. Gravatar of Major_Freedom Major_Freedom
    23. June 2012 at 18:37

    The public has no idea what Bernanke means when he calls for higher inflation. For Bernanke, that’s a code word for “higher real incomes for Americans.” But the public sees inflation 100% in supply-side terms, as higher prices HOLDING MY INCOME FIXED. In that environment it makes zero sense to talk about the public’s view of inflation. Yes, they don’t like falling real incomes, but no one is proposing that.

    You are proposing that. Bernanke is proposing that. Monetarists are proposing that. Keynesians are proposing that. EVERYONE who is calling for monetary inflation is proposing that.

    You all propose it through the following: If monetary inflation raises one person’s real income by 10% (because their nominal income is increased first), while it decreases another person’s real income by 5% (because their nominal income is not increased at this time), and we assume they both originally earned the same income, then the two people are put into a blender, mixed up, and poured into an “average person” mold, and the claim is made that the real income of the “average person” increased by roughly 5%.

    Inflation does reduce the real income of those who receive the new money last, after it has already increased the prices of goods and services those people bought in the meantime.

    Seriously, what is with monetarists ignoring the Cantillon effect?

    We’ve averaged 1.1% inflation over the past 46 months.

    We’ve averaged 2.5% inflation since 2000.

    Long term inflation is consistent with the Fed’s current mandate.

    The 1.1% inflation over the last 46 months is a reduction of real income of at least 1.1% for all those whose nominal incomes have NOT risen by 1.1% in the last 46 months, but something less.

    I argue it’s even more than 1.1%, because the BLS, as everyone without a hole in their head knows, systematically underreports the rate of inflation.

    For example, if the inflation calculation methodology they used during the 1980s is used, before they introduced the hedonic adjustment (e.g. “You mean steak has increased so much in price that people are now buying ground beef? OK, just replace the higher quality steak with the lower quality ground beef, and report zero price inflation for “beef”!”), then price inflation today would be around 5%.

    Anybody think the public is enjoying those low inflation rates more than the 2-3% inflation of the Clinton years?

    For those who are earning a fixed wage, or fixed income in general, of course they are enjoying 1.1% inflation more than they enjoyed 2-3% under Clinton. Their real incomes are being reduced by a lower rate!

    Then there is the fact that real wages for production workers have stagnated since 1971. Hmmm, I wonder what significant event occurred in 1971?

    I think the reason is that Americans suddenly stopped being innovative that year. No wait, that’s obviously trying to cover up for another event that occurred. I wonder what it could be?

    Anybody think the public is enjoying the abandonment of the last vestiges of the gold standard more than the “tight”, “choking”, “stingy”, “hand-cuffed central banks” time in US history when real wages were increasing pre-1971?

    But yes, obviously the solution to stagnant wages is for the central bank to devalue their real wages even more by inflation. It’s never worked before, but it’s gotta work eventually! Have faith everyone! Trust me! I am a PhD economist. Shut up and don’t you dare question my intelligence. I spent many piles of toilet paper paying for my “education”, and I demand respect!

  3. Gravatar of Tomasz Wegrzanowski Tomasz Wegrzanowski
    23. June 2012 at 18:38

    How Swiss are handling it? They’ve been quite successful doing direct democracy.

    I’d assume that if any such issue were campaigned on, people would get at least as much understanding as average Congress member has (which is not to say all that much).

    Also Buffett is right and you’re wrong on taxes. If the rich really paid that 30% tax, that would way more money than now.

  4. Gravatar of Justin Irving Justin Irving
    23. June 2012 at 19:02

    Could someone explain to me how we should tax people like Buffet? Unlike most, his *job* is managing capital. When Buffet buys a railroad after presumably years of thinking and research, that’s different than the man in the street putting money in an index fund.

    Buffet and the other big players who—I propose—add value by making markets more forward looking, are doing more than just investing and saving, they are doing work. It seems to me that this calls for the consumption tax to be put on the spending side not the income side. A VAT, not a progressive payroll tax. Anyone have thoughts on this? I recall Scott saying that income from working at a hedge fund should fall under the hypothetical progressive payroll tax. So then where do we get the Buffets? It seems silly to me for Buffet to pay no taxes under the idea that he paid his ‘fair share’ back in the 1960s or whenever he stopped punching a clock. I feel I am missing something.

  5. Gravatar of Major_Freedom Major_Freedom
    23. June 2012 at 19:14

    I don’t get where the “We’ve averaged 1.1% inflation over the past 46 months” is coming from.

    From FRED, I get:

    2008-08-01 5.3
    2008-09-01 5.0
    2008-10-01 3.7
    2008-11-01 1.1
    2008-12-01 0.0
    2009-01-01 -0.1
    2009-02-01 0.1
    2009-03-01 -0.4
    2009-04-01 -0.6
    2009-05-01 -1.0
    2009-06-01 -1.3
    2009-07-01 -2.0
    2009-08-01 -1.5
    2009-09-01 -1.4
    2009-10-01 -0.2
    2009-11-01 1.9
    2009-12-01 2.8
    2010-01-01 2.6
    2010-02-01 2.1
    2010-03-01 2.3
    2010-04-01 2.2
    2010-05-01 2.0
    2010-06-01 1.1
    2010-07-01 1.4
    2010-08-01 1.2
    2010-09-01 1.1
    2010-10-01 1.2
    2010-11-01 1.1
    2010-12-01 1.4
    2011-01-01 1.6
    2011-02-01 2.1
    2011-03-01 2.6
    2011-04-01 3.1
    2011-05-01 3.4
    2011-06-01 3.5
    2011-07-01 3.6
    2011-08-01 3.8
    2011-09-01 3.9
    2011-10-01 3.6
    2011-11-01 3.5
    2011-12-01 3.0
    2012-01-01 2.9
    2012-02-01 2.9
    2012-03-01 2.6
    2012-04-01 2.3
    2012-05-01 1.7

    Average = 1.8

  6. Gravatar of Major_Freedom Major_Freedom
    23. June 2012 at 19:23

    Justin:

    Could someone explain to me how we should tax people like Buffet?

    The non-cowardly way, or the cowardly way?

    The non-cowardly way is to find a way to get to him, point a gun at him, demand that he pay up, and threaten to throw him into a cage if he refuses, and threaten to shoot him if he refuses to accept the cage and defends himself.

    The cowardly way is to find a person dirty enough and immoral enough to do it for you, in which case you can plead to the crooks in Washington to tell their thugs with badges to point a gun at him, demand that he pay up, and threaten to throw him into a cage if he refuses, and threaten to shoot him if he refuses to accept the cage and defends himself.

    If you choose the cowardly route, and you can get enough other cowards to join you in your pleading, and you outnumber those who act more…civilized, you can all consider yourselves acting “democratically”, and doing God’s, I mean “society’s” good work, in getting “the rich to pay their fair share.”

    But I think Buffet has a little more “pull” in Washington than you do, so he’ll probably succeed in getting taxes raised for his major competitors, the short term speculators, while his type of investments are not taxed more.

  7. Gravatar of Major_Freedom Major_Freedom
    23. June 2012 at 19:28

    Tomasz Wegrzanowski:

    How Swiss are handling it? They’ve been quite successful doing direct democracy.

    It depends on the philosophy and morals of the people. The lazier and more parasitical the people, the worse the outcomes.

    It’s not working out so well in California. Their deficit is $16 billion(!), and unlike the Swiss, they can’t print their own money.

  8. Gravatar of Jim Glass Jim Glass
    23. June 2012 at 20:05

    I don’t get where the “We’ve averaged 1.1% inflation over the past 46 months” is coming from. From FRED, I get: … Average = 1.8

    That’s neither how to compute an average percentage increase nor how to compute a CPI increase.

    CPI from 2008-07-01 until 46 months later,
    2012-05-01: up from 219.090 to 228.527, = by 1.00091720 per month, = by 1.01106207 per 12 months, = 1.106% annual.

    Who’s surprised?

  9. Gravatar of D.Gibson D.Gibson
    23. June 2012 at 20:22

    It is very true that nearly everyone is ignorant of the importance of monetary policy. I was at the bookstore today. They had about 200 different books in the Economics section. Exactly zero had the word “money” in title. The only things I ever hear from the mainstream media are “The Fed can do no more”. And, “There are worries that inflation will get out-of-control.”

    So, rather than having a public discourse about how the Fed is failing with tight money, we end up with a battle over “the rich” paying more. Unfortunate. It is like the populous being ignorant about gravity and yet we spend all the time wondering why things keep falling.

    That said, Mitt Romney pays 14%. Teenagers flipping burgers pay twice that. What we *should* do is pick a tax system that efficient, uncorrupted by politicians, and perceived as fair by most folks. Consumption and wealth taxes are best, IMO.

    Back to the populous and polls. Sure people want lots of services and little taxes. Why is anybody surprised by that? That doesn’t mean that actually expect it.

  10. Gravatar of Kevin Dick Kevin Dick
    23. June 2012 at 21:23

    Re: MF’s disputing Scott’s calculation of average inflation. Wow. Just wow.

  11. Gravatar of Major_Freedom Major_Freedom
    23. June 2012 at 21:42

    Jim Glass:

    CPI from 2008-07-01 until 46 months later,
    2012-05-01: up from 219.090 to 228.527, = by 1.00091720 per month, = by 1.01106207 per 12 months, = 1.106% annual.

    Yeah I was thinking that was the method used, but then I was thinking that probably wasn’t it, because the calculation depends quite a bit on the chosen initial and ending values and can end up giving a biased answer.

    For what if the CPI was rising by 5% annually for the first 45 months, but then during the 46th month, the CPI plummeted? That would result in a lower calculated annual rate if we just pick the start and end date, even though 45 out of the 46 months the CPI was increasing. So to me, the calculated average wouldn’t really be representative of what has been happening.

    Similarly, what if the CPI was falling for 45 straight months, but then in the 46th month, the CPI skyrocketed? That would result in a higher average inflation rate, that is also not really representative of what’s been happening throughout the period.

    That’s why I thought it would be better to use annual rates each month and then average those out. This is because it is like taking 46 different sets of start and end values, which would minimize any possible misrepresentation that comes with picking only one pair of starting and ending values.

    If what I did makes no sense, what do you suggest that would give a representative rate of inflation, that isn’t so dependent on the start and end values? Average monthly change of CPI, annualized?

  12. Gravatar of Major_Freedom Major_Freedom
    23. June 2012 at 21:44

    Kevin Dick:

    I wasn’t “disputing” it, I just wanted to know how he calculated it, because there is much weight being put on start and end values.

  13. Gravatar of Major_Freedom Major_Freedom
    23. June 2012 at 22:21

    Three-quarters of likely voters believe the nation’s top earners should pay lower, not higher, tax rates, according to a new poll for The Hill.

    The big majority opted for a lower tax bill when asked to choose specific rates; precisely 75 percent said the right level for top earners was 30 percent or below.

    The current rate for top earners is 35 percent. Only 4 percent thought it was appropriate to take 40 percent, which is approximately the level that President Obama is seeking from January 2013 onward.

    Wow, that is rather surprising. The majority of people want the rich to pay less taxes? Has Ron Paul been that effective, or is this poll biased and/or misleading the questioners in some way?

  14. Gravatar of Major_Freedom Major_Freedom
    23. June 2012 at 22:35

    Jim Glass:

    I said: “what do you suggest that would give a representative rate of inflation, that isn’t so dependent on the start and end values? Average monthly change of CPI, annualized?”

    Not sure if my numbers are right, but from this:

    Date/ CPI/ Change/ Annualized inflation/
    2008-01-01 100.0
    2008-02-01 100.2 0.2 1.024242462
    2008-03-01 100.6 0.4 1.047252289
    2008-04-01 100.8 0.2 1.030387589
    2008-05-01 101.4 0.6 1.072119522
    2008-06-01 102.5 1.1 1.135817014
    2008-07-01 103.2 0.8 1.095557838
    2008-08-01 103.1 -0.2 0.980886711
    2008-09-01 103.1 0.1 1.006977415
    2008-10-01 102.2 -0.9 0.897383307
    2008-11-01 100.4 -1.8 0.800804009
    2008-12-01 99.6 -0.8 0.90938737
    2009-01-01 99.9 0.3 1.032189773
    2009-02-01 100.3 0.4 1.049791409
    2009-03-01 100.2 -0.1 0.985283803
    2009-04-01 100.2 0.1 1.008174871
    2009-05-01 100.4 0.1 1.015490503
    2009-06-01 101.2 0.8 1.104631121
    2009-07-01 101.2 0.0 0.998981676
    2009-08-01 101.5 0.4 1.043424219
    2009-09-01 101.7 0.2 1.023087564
    2009-10-01 102.0 0.3 1.034054241
    2009-11-01 102.3 0.3 1.036623544
    2009-12-01 102.4 0.1 1.012340453
    2010-01-01 102.5 0.1 1.007889586
    2010-02-01 102.4 0.0 0.99593599
    2010-03-01 102.5 0.0 1.002433911
    2010-04-01 102.4 0.0 0.996218171
    2010-05-01 102.3 -0.1 0.989252112
    2010-06-01 102.4 0.0 1.001358045
    2010-07-01 102.6 0.2 1.025340844
    2010-08-01 102.8 0.2 1.023607243
    2010-09-01 102.9 0.1 1.017212719
    2010-10-01 103.2 0.3 1.037735332
    2010-11-01 103.4 0.2 1.024068292
    2010-12-01 103.9 0.5 1.05643394
    2011-01-01 104.2 0.3 1.035747045
    2011-02-01 104.6 0.5 1.056373369
    2011-03-01 105.2 0.6 1.069109844
    2011-04-01 105.6 0.4 1.048373269
    2011-05-01 105.9 0.3 1.034696638
    2011-06-01 106.0 0.1 1.011539789
    2011-07-01 106.3 0.3 1.0390222
    2011-08-01 106.6 0.4 1.043305695
    2011-09-01 106.9 0.3 1.034696638
    2011-10-01 106.9 0.0 0.996274377
    2011-11-01 107.0 0.1 1.011940048
    2011-12-01 107.0 0.0 1.00107573
    2012-01-01 107.2 0.2 1.027020569
    2012-02-01 107.7 0.4 1.053760483
    2012-03-01 108.0 0.3 1.038260585
    2012-04-01 108.0 0.0 1.004476759
    2012-05-01 107.7 -0.3 0.963854611

    I get an average annual inflation rate of 1.019075049, or 1.9% per year when we take the monthly averages.

    This is closer to my original method of 1.8%, the one that took the annual rates measured at each month (which of course means it is utilizing start date CPI data from 2007).

    If my math is right, I think this is the most representative average of inflation for the period in question. It minimizes any bias from picking an out of the ordinary starting value.

  15. Gravatar of Major_Freedom Major_Freedom
    23. June 2012 at 22:41

    Actually the 1.9% is from the beginning of 2008.

    From 2008-07-01 to the latest date, I get an average of 1.5%.

  16. Gravatar of johnleemk johnleemk
    23. June 2012 at 22:49

    MF:

    And none of your numbers match, let alone exceed, the Fed’s stated goal of 2% inflation. By any count, the Fed has abdicated both its inflation AND its unemployment mandates. Sure, the end and beginning points are to some degree arbitrary. But if by any reasonable slicing of the data, we find that the Fed in recent years has not been doing its job of supplying enough money to meet demand, why are we quibbling over percentage points?

  17. Gravatar of Major_Freedom Major_Freedom
    23. June 2012 at 23:03

    Actually, forget about the public, I’d estimate that half the economists I talk to don’t understand that taxes on capital are double taxing the same wage income.

    That’s because half of the economists out there are anti-capitalist ideologues who think attacking “the rich” is a pathway to prosperity in a division of labor society, as if we’re living in a feudal society.

    They have no clue that the majority of wealth “the rich” own is in the form of factories, machinery, materials, which are for the physical benefit of the CONSUMERS.

    There should be ZERO taxes on capital. If taxes have to exist, they should be fully on consumption alone. Imagine the poor being able to invest their earnings TAX FREE. They’d be able to accumulate capital and compete with the established firms far more easily.

    But right now? Suppose you ask the public if spending $689 billion on the military is too much or too little. Then ask them whether spending 4.1% of national income on the military is too much or too little. Then ask them whether they believe we are currently spending too much or too little on the military.

    Question for market monetarists:

    If you had to choose between -5% NGDP growth and less military industrial complex spending, or 5% NGDP growth and military industrial complex spending, which would you choose?

    Assume that the military spending is something you don’t agree with, like bombing villages who refuse to allow oil companies to demolish the towns to put pipelines through. Just imagine something really heinous in your mind.

  18. Gravatar of RobertD RobertD
    23. June 2012 at 23:16

    Scott, you’ve mentioned a “progressive consumption tax” before. Do you mean a tax at the point of sale, where luxury items like cruise ships are taxed higher, but the basic needs like milk, break, and toilet paper are taxed at a low rate, if at all? Or are you talking about a fancy type of VAT? Personally, I like the idea of just having a VAT and needs testing Social Security. That would be inherently progressive, but not sure if any group has the political power/will to push something like that through the system.

  19. Gravatar of johnleemk johnleemk
    23. June 2012 at 23:31

    RobertD,

    Taxing only wage income (and you could make the rates/brackets ridiculously progressive) while eliminating all taxes on corporations and capital gains would, in principle, be equivalent to a consumption tax; the more progressive the payroll tax, the more progressive the effective tax on consumption. I think from what he’s said before that this would be Scott’s preferred policy.

  20. Gravatar of Major_Freedom Major_Freedom
    23. June 2012 at 23:33

    johnleemk:

    And none of your numbers match, let alone exceed, the Fed’s stated goal of 2% inflation. By any count, the Fed has abdicated both its inflation AND its unemployment mandates.

    First, I don’t think my numbers were right.

    I now get 1.4% since 2008-07-01:

    Date / CPI / change / annualized
    2008-07-01 219.090 0.007449303 1.093146606
    2008-08-01 218.749 -0.001556438 0.981481802
    2008-09-01 218.872 0.000562288 1.006768366
    2008-10-01 216.966 -0.008708286 0.900363149
    2008-11-01 213.074 -0.017938294 0.804758029
    2008-12-01 211.401 -0.007851732 0.909743458
    2009-01-01 211.962 0.002653724 1.032313618
    2009-02-01 212.823 0.004062049 1.049848483
    2009-03-01 212.561 -0.00123107 0.985326776
    2009-04-01 212.705 0.000677453 1.00815979
    2009-05-01 212.977 0.001278766 1.015453584
    2009-06-01 214.744 0.008296671 1.104231158
    2009-07-01 214.726 -8.38207E-05 0.998994615
    2009-08-01 215.479 0.003506795 1.042902741
    2009-09-01 215.883 0.001874893 1.022732173
    2009-10-01 216.476 0.002746858 1.033464872
    2009-11-01 217.113 0.002942589 1.035888199
    2009-12-01 217.330 0.00099948 1.012059906
    2010-01-01 217.469 0.00063958 1.00770202
    2010-02-01 217.397 -0.000331082 0.996034247
    2010-03-01 217.440 0.000197795 1.002376122
    2010-04-01 217.373 -0.000308131 0.996308688
    2010-05-01 217.182 -0.000878674 0.98950672
    2010-06-01 217.206 0.000110506 1.001326883
    2010-07-01 217.649 0.002039539 1.024750878
    2010-08-01 218.062 0.001897551 1.023009763
    2010-09-01 218.364 0.001384927 1.016746302
    2010-10-01 219.020 0.003004158 1.036651551
    2010-11-01 219.441 0.001922199 1.023311816
    2010-12-01 220.414 0.004433994 1.054524874
    2011-01-01 221.036 0.002821962 1.034394112
    2011-02-01 222.008 0.004397474 1.054064872
    2011-03-01 223.193 0.005337645 1.065965977
    2011-04-01 224.030 0.003750118 1.045941296
    2011-05-01 224.634 0.002696067 1.032836887
    2011-06-01 224.837 0.000903692 1.010898369
    2011-07-01 225.515 0.003015518 1.03679245
    2011-08-01 226.266 0.003330155 1.040701987
    2011-09-01 226.870 0.002669424 1.032507608
    2011-10-01 226.804 -0.000290916 0.996514594
    2011-11-01 227.014 0.00092591 1.011167673
    2011-12-01 227.033 8.36953E-05 1.001004806
    2012-01-01 227.505 0.002078993 1.025235167
    2012-02-01 228.433 0.004079031 1.050061585
    2012-03-01 229.098 0.002911138 1.035498452
    2012-04-01 229.177 0.000344831 1.004145824
    2012-05-01 228.527 -0.002836236 0.966491103

    Average = 1.013917 = 1.4%

    ——-

    Two, can we say that the Fed has failed to attain 2% inflation, even if we consider the long term, say back to 2000?

    Doing that I get 2.55%.

    Sure, the end and beginning points are to some degree arbitrary.

    Yes, and this was precisely the motivation for my (disastrous) initial attempt to get a less arbitrary measurement for inflation. I want to avoid that problem of relying on a particular initial data point.

    But if by any reasonable slicing of the data, we find that the Fed in recent years has not been doing its job of supplying enough money to meet demand, why are we quibbling over percentage points?

    Ah, but what exactly does “reasonable” mean? What’s reasonable to you might not be reasonable to someone else. There has to be more objectivity.

    Isn’t the 2% price inflation goal a LONG term goal? If the Fed sought above 1.4% inflation (that’s the last time I paste my numbers I promise!) today, then wouldn’t they be above their long term goal? They’re at 2.55% since the beginning of 2000 (using my monthly average method (and 2.44% using Sumner/Glass method).

    Bernanke once said to Ron Paul that the main goal of the Fed is “price stability” (meaning 2% inflation), and he once responded to Krugman that he doesn’t want the Fed to lose its credibility with higher price inflation.

    Seriously, so what if inflation has been below 2% since July 2008? It was over 5% at one point in 2008. Long term, I don’t see the Fed failing in its inflation goal.

    I do see a failure in its employment goal, but then again, price inflation for output never was the source of employment anyway (see the stagflation of the 1970s, where price inflation went up, but employment went down).

    So basically the Fed is succeeding in maintaining long term price inflation, and failing to raise employment, which cannot be accomplished by price inflation anyway.

  21. Gravatar of Major_Freedom Major_Freedom
    23. June 2012 at 23:51

    johnleemk:

    Taxing only wage income (and you could make the rates/brackets ridiculously progressive) while eliminating all taxes on corporations and capital gains would, in principle, be equivalent to a consumption tax

    If the fall in after tax wage income is offset by an elimination of taxes on capital (profits, interest, capital gains, dividends, etc), such that wage earners who invest have equivalent after tax income (wages plus profits/interest/gains/dividends/etc), then is it really a consumption tax?

    Maybe for those who don’t invest, they would end up earning less after tax income, but then because of the elimination of taxes on capital, there would almost certainly be a rise in capital investment, and hence a rise in the productivity of labor, so that might lead to a rise in real wages, if the increase in capital investment and productivity is sufficient enough to offset the fall in after tax wages such that wage earners experience a higher standard of living.

    But taxing only wages is a fascistic policy, and should not be pursued.

    The worst is tax cuts not matched by government spending cuts. That undermines capital formation even more than no tax cuts and the same government spending, because the difference must be made up for by borrowing, and that means less savings available for private investment.

    the more progressive the payroll tax, the more progressive the effective tax on consumption. I think from what he’s said before that this would be Scott’s preferred policy.

    Taxing only wages? I doubt that.

  22. Gravatar of Saturos Saturos
    23. June 2012 at 23:55

    RobertD, he probably means a flat rate VAT combined with a lump-sum demogrant, like Kotlikoff (and I) advocates.

    Scott, you said:

    If you simply sat them down and showed them the books they’d radically alter their policy views.

    You mean like this? http://content.thirdway.org/publications/335/Third_Way_Idea_Brief_-_A_Taxpayer_Receipt.pdf
    http://www.theatlantic.com/business/archive/2011/04/where-do-your-tax-dollars-go-a-long-story-in-5-quick-graphs/237128/

    Another thing I advocate.

  23. Gravatar of Kevin Dick Kevin Dick
    24. June 2012 at 00:06

    @MF. Well, apparently you are in fact disputing whether this is the appropriate way to calculate the average inflation.

    What astounded me was that this is simply the difference between an arithmetic and geometric mean. When you have a compounding process like inflation, you use the geometric mean. This is typically covered in second year high school algebra via a painful problem set showing why the arithmetic mean doesn’t work in this situation.

    There is no extra “weight being put on start and end values”. The point of _any_ average is to answer the question, “For the sake of argument, say all observations during the period were exactly the same. What would they have to have been to produce this result.” An arithmetic mean also has the problem of not being representative when you have extreme outliers.

    Because inflation in one period compounds (i.e., multiplies) on the inflation in the previous period, you _must_ use the geometric mean. So, when you say the average over X months is Y%, it _must_ be the case that (1+Y/100)^X = B/A where A is the value in the start month and B is the value in the end month.

    So let’s see how your 1.9% calculation stacks to the definition of an average. This means if we had used a 1.9% inflation in every period, we would get the same price change we actually observed.

    CPI on 2008-07-01 = 219.090

    2012-05-01 = 46 months later

    MF’s estimate = 219.090 * (1.019)^46 = 520.76

    Actual CPI = 228.53

    MF’s error = 128%

    So if we follow your procedure, your result implicitly overestimate the total change in prices level by more than double. Not what we want.

  24. Gravatar of John Thacker John Thacker
    24. June 2012 at 00:10

    I am fairly sure that many of the poll responders did not and do not make a clear distinction between marginal rates and average rates of tax.

    That itself is not surprising, considering that expert commentators and talking heads confuse the issue themselves all the time, and often compare some rich person’s average tax rate to a middle class person’s marginal rate.

  25. Gravatar of Major_Freedom Major_Freedom
    24. June 2012 at 00:33

    Kevin Dick:

    @MF. Well, apparently you are in fact disputing whether this is the appropriate way to calculate the average inflation.

    Sure, but not the calculation. That’s why I asked.

    What astounded me was that this is simply the difference between an arithmetic and geometric mean. When you have a compounding process like inflation, you use the geometric mean. This is typically covered in second year high school algebra via a painful problem set showing why the arithmetic mean doesn’t work in this situation.

    I disagree. I think an arithmetic mean is justified for independent events like monthly rates of inflation. I do not hold that the rate of inflation last month “decides” this month’s rate of inflation.

    Geometric means are more appropriate for a series whose changes are correlated, such as guaranteed interest bonds and so on.

    There is no extra “weight being put on start and end values”.

    I disagree. Suppose 2008-07-01 had a sudden, out of the ordinary massive inflation or deflation. Your method would show a vastly different average rate of inflation for the period in question, whereas my average would be more representative of what actually happened.

    The point of _any_ average is to answer the question, “For the sake of argument, say all observations during the period were exactly the same. What would they have to have been to produce this result.”

    Sure, I can accept that.

    An arithmetic mean also has the problem of not being representative when you have extreme outliers.

    That problem exists with geometric means when your initial data point is itself an extreme outlier.

    Because inflation in one period compounds (i.e., multiplies) on the inflation in the previous period, you _must_ use the geometric mean.

    I disagree. The absolute values each period are a function of compounding, but the changes in each month are independent.

    So, when you say the average over X months is Y%, it _must_ be the case that (1+Y/100)^X = B/A where A is the value in the start month and B is the value in the end month.

    Yes, the geometric mean calculation MUST be that, but then so what?

    So let’s see how your 1.9% calculation stacks to the definition of an average. This means if we had used a 1.9% inflation in every period, we would get the same price change we actually observed.

    CPI on 2008-07-01 = 219.090

    2012-05-01 = 46 months later

    MF’s estimate = 219.090 * (1.019)^46 = 520.76

    Actual CPI = 228.53

    MF’s error = 128%

    You remember when you told me “Wow. Just wow”?

    Well I will tell YOU “Wow. Just wow.”

    You forgot to convert the 1.9% annual inflation to a monthly rate before compounding it 46 times!

    Oops

    We have the same “problem” with your 1.1% inflation estimate.

    219.09 * (1.011)^46 = 362.38

    Actual CPI = 228.53

    Kevin’s error: 159%

    If you convert my 1.9% annual inflation to MONTHLY inflation, we get 1.019^(1/12) = 1.00156971

    If we then take THAT monthly inflation rate, we get

    219.090 * (1.00156971)^46 = 235.4815726

    Actual CPI = 228.53

    Not so off now is it?

    So if we follow your procedure, your result implicitly overestimate the total change in prices level by more than double. Not what we want.

    If we follow your procedure, your result implicitly overestimates the total change in prices by more that 3/2.

    Or, you know, you could have converted the annual 1.9% to monthly rate, then compounded it!

  26. Gravatar of Major_Freedom Major_Freedom
    24. June 2012 at 00:39

    “Kevin’s error: 159%”

    Sorry, typo, that would be 59%.

  27. Gravatar of Major_Freedom Major_Freedom
    24. June 2012 at 00:46

    Kevin Dick:

    And I recalculated my estimate to be 1.4%, vice 1.9%.

    With 1.4% annualized converted to , the “implied” ending CPI is

    219.090 * (1.001159247)^46 = 231.08

    Actual CPI = 228.53.

    Even closer.

  28. Gravatar of Major_Freedom Major_Freedom
    24. June 2012 at 00:53

    Of course it won’t be exactly the same, precisely because your method rests entirely on the initial starting value, so your estimate “pops out” of the initial and ending values by construction.

    Mine does not do that. It works the other way. Mine is an average of all the monthly changes. Even if the initial starting month is an “outlier”, my method “attenuates” that outlier and gives it less importance than your method. If it’s not an outlier, then my method still isn’t any less effective.

  29. Gravatar of Major_Freedom Major_Freedom
    24. June 2012 at 01:08

    Kevin Dick:

    Here’s an example:

    Suppose the initial starting CPI for 2008-07-01 is an “outlier” of 300.00, after which the rest of the data is as it was before.

    Using your method, the average would become:

    (228.53/300)^(1/46) = 0.994102 monthly.

    Annual = (0.994102)^12 – 1 = -0.0685 = -6.8%

    ——

    My method would put far less weight on the initial 300.00, and I would argue my estimate would be more representative of what happened over the last 46 months. People would hear my estimate, and say “yes, that sounds closer to the price inflation I have experienced the last while. -6.8%? That doesn’t make sense to me, because for the last 3 years at least, I have been paying gradually higher prices. Yes, I remember that one time 45 months ago when prices fell big time that one month, but that was short lived. It’s been price inflation since then.”

  30. Gravatar of Major_Freedom Major_Freedom
    24. June 2012 at 01:19

    Kevin, I think it’s just a matter of philosophical differences, based on how we interpret each month’s change in the CPI.

    I hold each month’s change as independent from every other month’s change, and so I argue the arithmetic mean estimate is appropriate.

    I think geometric means are only appropriate to use in the natural sciences.

  31. Gravatar of ThaomasH ThaomasH
    24. June 2012 at 04:10

    “Could someone explain to me how we should tax people like Buffet? Unlike most, his *job* is managing capital. When Buffet buys a railroad after presumably years of thinking and research, that’s different than the man in the street putting money in an index fund.”

    1) Abolish the corporate income tax and impute profits to shareholders, treating them as ordinary income.
    2) Define capital gains as increases in the inflation-adjusted value of investments.
    3) Allow the receiver of revalued capital gains to allocate the increase pro-rata over the years that the investment was held.
    4) Allow new investments (including increases in savings accounts, 410 K’s etc.) to be deducted from income.
    5) Tax the remainder (=”consumption”) at progressive rates.
    From what I’ve heard about Mr. Buffet’s lifestyle, he might pay considerably less under this scheme than he does now and might still pay a smaller portion of his INCOME in tax than his secretary, but not a smaller portion of his consumption.

    Would this be simpler than the current personal cum corporate income tax? Not necessarily if for no other reason than there would be deductions and special treatment of certain forms of consumption (Charitable deductions? Medical bills? Education? Home mortgage interest?), the complication of constantly carrying back income to previous tax years, policing corporate income and expenses to ensure that owners were not understating income on which they would be taxed and “investments” in hobbies.

  32. Gravatar of ssumner ssumner
    24. June 2012 at 05:02

    MF, You said;

    “Long term inflation is consistent with the Fed’s current mandate.”

    People have drowned in lakes with an average depth of 3 feet. What you don’t understand is that inflation has been lower than average when unemployment is high and vice versa, the exact opposite of what’s needed.

    Tomasz, The Swiss have done great because the public is forced to confront the effects of their opinions. More spending means more taxes, and the Swiss have opted for modestly lower spending than most other Europeans. They are more well-informed than Americans because they need to be.

    Justin, I agree that with someone like Buffett it would be easier to tax him when he makes purchases.

    MF, I see that math is also not your strong suit. Do you even have a strong suit?

    Jim Glass, I’m not surprised.

    D.Gibson, That’s right.

    Robert D, I’d like to see a mix of a mildly progressive VAT and a more steeply progressive payroll tax. The payroll tax would be negative at low wage rates, and any VAT paid by the poor would be rebated to them on an estimated basis. Thus if the VAT was 20%, and they earned $10,000, you’d give them a $2000 tax rebate to offset the VAT they pay at point of sale. Yes, I’d have higher VATs on mansions, yachts, expensive jewelry, private jets, etc.

    My main goal is to make it so that people like ME don’t get punished for saving a lot, and don’t have to fill out annoying tax forms. It’s all about making ME happier.

    ThaomasH, I don’t want to index taxes on capital, I want to abolish them. Indexing would be incredibly complicated for the average person.

  33. Gravatar of Tom Kelly Tom Kelly
    24. June 2012 at 05:42

    Math/Econometrics majors: give it a rest.

    The calculated rate of inflation is irrelevant when the underlying data is irrelevant. No one actually lives on the CPI components.

    For my lifestyle, inflation has been around 20% total over the last 5 years. I spend my money on food, fuel, entertainment, and medical. My houses and cars are paid for.

    I have a chronic condition that requires a simple doctor’s visit to renew a prescription every 6 months. In 5 years that visit has gone from $120 to $175.

    Matinee movie tickets have gone from $6 to $8.50.

    My “standard meal” at McDonald’s has gone from $5.50 to $7.00.

    And obviously gas is way up.

    People care less about government economic statistics, they have their own stats every time they spend money.

  34. Gravatar of Michael Michael
    24. June 2012 at 05:49

    ““You mean steak has increased so much in price that people are now buying ground beef? OK, just replace the higher quality steak with the lower quality ground beef, and report zero price inflation for “beef”!”)”

    Yes, that’s true for that example, but substitutions aren’t always necessarily inferior, eg. switching from bananas to oranges or between wooden and mechanical pencils.

    Heck, even in your example, if someone go from buying enough steak for one meal to enough ground beef for two meals, they may actually be happier. Some people may prefer a couple tasty burgers a week over one great steak.

    And, on the flip side, things like cell phones, TV’s have not only gotten cheaper, but also better. How do you compare the price of a new iPad to 4 years ago? Compare it to the inferior version? What about 10 years ago when it didn’t exist? And what if the switch from steak to ground beef was due to people trying to save money on food so they could buy this new product that didn’t even exist before? The new iPad money is going to come out of some other aspect of one’s budget. Is the switch from steak to ground beef + iPad necessarily inferior?

    It can also be hard to shake out the difference between legitimate price changes due to supply and demand, changing tastes, etc. from purely nominal ones. Imagine if the overall price level was constant. That doesn’t mean relative price levels between goods necessarily stays constant. There could be a legitimate demand or a supply shock that will change relative prices and cause people to make substitutions, but it’s not clear how one should factor this in when calculating the ONE TRUE PRICE LEVEL of a country.

    It’s really hard to encapsulate so many things with one single number. You do the best you can. There will be problems no matter what you do. Maybe the official rate does understate things, but you skip over the ways it could overstate things, or the examples where such a methodology makes sense.

  35. Gravatar of Lars Christensen Lars Christensen
    24. June 2012 at 06:02

    Scott, the income tax rates you are talking about sounds all Scandinavian…scary…

    Anyway, Bryan Caplan has said about what needs to be said about the issue of voter (ir)rationality. He would agree with you…

    “Interesting” discussion about the level of inflation in the US over past 4 years in the comments above. No matter how you calculate inflation and no matter what index you se it is impossible to find the kind of (hyper)inflation rate “Internet Austrians” have warned about for the the past four years…we are still waiting. Meanwhile is the market beginning to expect DEFLATION. Why is it that “Internet Austrians” never trust the markets? Are they socialists?

  36. Gravatar of Saturos Saturos
    24. June 2012 at 06:17

    MF, this one’s for you.

    Btw Lars, I dunno if you know this, but you’re following me on Twitter, @_Srijit. I think you followed me back when I followed you.

  37. Gravatar of Saturos Saturos
    24. June 2012 at 06:45

    The tech writer on Forbes is a market monetarist – or at least a monetarist: http://www.forbes.com/sites/timothylee/2012/06/20/monetary-policy-is-about-money-not-interest-rates/

    HT Marcus Nunes

  38. Gravatar of The Original D The Original D
    24. June 2012 at 06:51

    This argument over tax rate is itself deceptive. Dollars to donuts that the *effective* tax rate for most earners is lower than this. And for private equity and VC types who get carried interest, the rate is below 20%.

  39. Gravatar of RebelEconomist RebelEconomist
    24. June 2012 at 07:02

    I normally skip MF’s comments, but with such long lists of figures, you can hardly avoid getting his point. While I disagree with MF’s mathematical methods, I think his argument has some validity. If I recall correctly, the Fed’s 2% inflation “target” derives from Greenspan in the early 1990s when he said that the Fed’s aim should be to reduce inflation to a level where it was not a factor in business and household decisions, which when pressed, he put at about 2%. Now since the Boskin committee introduced methodological reforms from about 1996 that lowered the measured rate of inflation by about 3/4%, a measured rate of 1.1% in the last four years is about on target.

    It is, by the way, this kind of biased target shifting (the UK did something similar when it changed the BoE’s inflation target from RPI to CPI) that makes me sceptical about the commitment of many monetary authorities to genuinely holding down inflation, and hence sceptical what their motives might be for adopting NGDP targeting.

    On the subject of public surveys, one factor that influences responses is any kind of anchor that the survey provides. In the survey of tax rates that Scott mentions, a range of tax rates spanning only from less than 20% to more than 45% was presented, and the modal response is near the middle of this range. I dare say that the mode might have been a higher tax rate if the range had gone up to European style tax rates of 75% or more.

  40. Gravatar of David Pearson David Pearson
    24. June 2012 at 07:06

    Scott,
    It seems you are saying that the public should like (or a priori does like?) demand-side inflation.

    India is an interesting case. Perhaps inflation there was initially of the supply-shock variety (not clear). Nevertheless, the central bank seems to be following the “correct” path: passively easing (allowing a steep Rupee deval) in response to the supply shock. I wonder if the public is happy with the result:

    http://soberlook.com/2012/05/india-facing-stagflation.html

    http://soberlook.com/2012/06/indias-currency-spirals-out-of-control.html

  41. Gravatar of Doug Doug
    24. June 2012 at 07:38

    As Thacker mentioned, the public doesn’t even understand the difference between marginal and average tax rates. A 40% top rate ≠ “taking 40% of one’s income.”

    Even many of the commenters here do not understand how a progressive consumption tax would work. Google “X Tax” for the leading candidate. David Bradford, the creator of the X Tax, is the obvious person to read on this subject, but others have written well on the topic (e.g., Daniel Shaviro, the new book by Viard & Carroll). Also take a look at Ed McCaffery’s work for an alternative progressive consumption tax structure; his book “Fair Not Flat” is very accessible.

  42. Gravatar of Jason Jason
    24. June 2012 at 07:41

    John Thacker above made the point eloquently. Neither cited article even mentions the word “marginal”. To add some data, it appears that the “top rate” is actually closer to 20%

    http://www.nytimes.com/interactive/2012/01/18/us/effective-income-tax-rates.html

    The recommendation for a 30% “top rate” is basically the Clinton era “top rates” (effective non-marginal rate at the top).

    Interestingly, the broken out data has two peaks: one right above the current “top rate” and one right below it. This is consistent with status quo bias: a large group of people only want to slightly increase or slightly decrease “top tax rates”.

    People have experience with their tax rates. They see their paystubs and calculate their taxes once a year. They have feedback against their beliefs. Inflation is a made up concept prone to error involving baskets of goods that do or do not include food and gasoline sometimes (the only things people buy on a weekly basis). This means, according to Daniel Kahneman, people should be good judges of effective tax rates (not marginal tax rates unless they were printed on your paystubs or in the tax tables) and poor judges of inflation.

    Wisdom of crowds.

  43. Gravatar of Bill Ellis Bill Ellis
    24. June 2012 at 08:04

    S. Sumner said…

    …the public’s numbers don’t even add up—they want pie in the sky and lower taxes and more government goodies. If you simply sat them down and showed them the books they’d radically alter their policy views.

    I agree, but it is not practical. That is why during “normal” times I am a big fiscal hawk.
    It is borrowing that allows our politicians to promise everyone the services they want, while railing against “waste” as the cause of the debt. If we had sustained “Pay GO” what we were spending on would be clear to all. The voters would have clear choices.
    I believe that the result would be voters choosing services and higher taxes. Know one knows I guess but I would like to see it happen.

    But right now I want massive deficit spending…it is an emergency situation.

  44. Gravatar of D.Gibson D.Gibson
    24. June 2012 at 08:26

    Here’s the problem with “double tax on capital” argument: it ignores the double tax on human capital. I claim that my wages above some very low minimum are actually the result of my education. An education that I paid for with after tax money. Therefore nearly all my wages are a return on capital.

    If you want to go further, one could argue that our lifespans are actually a form of capital. And that selling that capital in small shares (hours or weeks or months) is actually a long-term capital gain and thus should not be taxed. The original tax being paid by the parents in raising the child.

  45. Gravatar of Saturos Saturos
    24. June 2012 at 09:07

    D.Gibson, your argument makes no sense. You suggest that we are ignoring a “double tax on human capital”. You then suggest that wage taxation is human capital taxation. But you do not identify any double taxation here. The argument for the existence of double taxation on capital is that capital income is already taxed when wage income is taxed, as the taxed dollars could have been substituted for future consumption by saving. But the tax on uneducated income does not overlap into a tax on income from education – they are distinct taxes on each of the two goods. Capital is double taxed in the same way that cigarettes are – first our cigarette consumption is taxed when we pay our income tax (shifting in our budget constraint with respect to cigarettes) and then again when a specific tax is levied on cigarettes. Now cigarette consumption does not underpin the economy the way that investment-in-general does, and there is a Pigovian argument for taxing it. But taxing capital is less efficient than raising the present value of the same revenues through consumption taxes.

  46. Gravatar of dwb dwb
    24. June 2012 at 09:20

    Yep: the public views inflation in terms of oil prices.

    The NYT has a piece quite a while ago where they asked the public to balance the budget. the results, as i recall were pretty contradictory.

    public opinion polls are very sensitive to how one asks the question, whether you present tradeoffs “would you prefer slightly higher inflation or continued unemployment?” and of course, who you think a likely voter is.

  47. Gravatar of Steve Steve
    24. June 2012 at 09:36

    You could have mentioned that 80% of Greeks support remaining in the Euro. What percentage of Greeks would support nominal wage growth?

  48. Gravatar of Shane Shane
    24. June 2012 at 09:42

    D. Gibson: fantastic point. I would go further and say that the “double taxation” argument more generally is almost always slightly disingenuous, as it smuggles highly selective judgments of fairness, i.e., deontological, concerns into an argument ostensibly about efficiency and utility. We double tax investment in human capital, we often triple tax certain wage income (we pay income tax on sales tax applied to excise taxes)–there’s nothing inherently inefficient of unfair about multiple taxation, and indeed it would be a nightmare to design a system that avoided it altogether. Furthermore, the current system effectively only imposes single taxation on unusually large returns to capital–Mark Zuckerberg invested very little of his own wage income, and now owns shares worth billions of dollars. There’s effectively no double taxation in such cases.

    I think utilitarians should avoid the double taxation argument altogether; indeed, it is almost always deployed in a highly selective, highly misleading way in order to make it seem morally suspect to impose a tax that will fall disproportionately on the wealthy. The same people very rarely consistently decry other forms of multiple taxation. If they applied the deontological argument consistently, then they would criticize the triple taxation of consumption–can someone find an example of this? If they applied the utilitarian form of the argument consistently, they would equally vociferously denounce double taxation on development of human capital–why should not just school, but also healthy food, gym memberships, books, bicycles, medical care, fashionable clothing, grooming products, fancy wines and wine tasting seminars, all be double taxed? These are arguably as much investments, and human capital is just as crucial for competitiveness and growth, if not more so, as physical capital.

  49. Gravatar of dwb dwb
    24. June 2012 at 09:52

    @MF,
    I think an arithmetic mean is justified for independent events like monthly rates of inflation.

    except when using a monthly year-over-year (YoY) averages, the observations are not independent. each YoY change overlaps the previous one by 11 months. one can get significant error when using overlapping periods to estimate (unless the period is really long), never do this!

    also, by including YoY changes starting in august 2008, you are including 11 months of inflation prior to august 2008.

    sure, in any average one might get 45 “2%) and one -100% which skews the average. That’s why we have this other metric called the standard deviation.

  50. Gravatar of dwb dwb
    24. June 2012 at 10:10

    @MF,

    if you do it the correct way using month-over-month changes instead of monthly YoY changes, then you get pretty close to the correct answer:

    observation_date CPIAUCSL_NBD20080701 MoM % chg
    2008-07-01 100.0
    2008-08-01 99.8 -0.16%
    2008-09-01 99.9 0.06%
    2008-10-01 99.0 -0.87%
    2008-11-01 97.3 -1.79%
    2008-12-01 96.5 -0.79%
    2009-01-01 96.7 0.27%
    2009-02-01 97.1 0.41%
    2009-03-01 97.0 -0.12%
    2009-04-01 97.1 0.07%
    2009-05-01 97.2 0.13%
    2009-06-01 98.0 0.83%
    2009-07-01 98.0 -0.01%
    2009-08-01 98.4 0.35%
    2009-09-01 98.5 0.19%
    2009-10-01 98.8 0.27%
    2009-11-01 99.1 0.29%
    2009-12-01 99.2 0.10%
    2010-01-01 99.3 0.06%
    2010-02-01 99.2 -0.03%
    2010-03-01 99.2 0.02%
    2010-04-01 99.2 -0.03%
    2010-05-01 99.1 -0.09%
    2010-06-01 99.1 0.01%
    2010-07-01 99.3 0.20%
    2010-08-01 99.5 0.19%
    2010-09-01 99.7 0.14%
    2010-10-01 100.0 0.30%
    2010-11-01 100.2 0.19%
    2010-12-01 100.6 0.44%
    2011-01-01 100.9 0.28%
    2011-02-01 101.3 0.44%
    2011-03-01 101.9 0.53%
    2011-04-01 102.3 0.38%
    2011-05-01 102.5 0.27%
    2011-06-01 102.6 0.09%
    2011-07-01 102.9 0.30%
    2011-08-01 103.3 0.33%
    2011-09-01 103.6 0.27%
    2011-10-01 103.5 -0.03%
    2011-11-01 103.6 0.09%
    2011-12-01 103.6 0.01%
    2012-01-01 103.8 0.21%
    2012-02-01 104.3 0.41%
    2012-03-01 104.6 0.29%
    2012-04-01 104.6 0.03%
    2012-05-01 104.3 -0.28%
    average 0.09%
    compounded 1.12%
    true 1.11%

    please, never never tell me where you (allegedly) got your MBA and who your bus stats professor was. ack!!

  51. Gravatar of dwb dwb
    24. June 2012 at 10:29

    @rebeleconomist:

    The official Fed target is 2% PCE, not CPI, which has averaged about 1.3% over the last 46 months. you can see this nice graph from Karl Smith on how the Fed has met its *dual* mandate:

    http://www.forbes.com/sites/modeledbehavior/2012/06/18/a-symmetrical-objective/

    so, no, not achieving 2/3 of its objectives.

  52. Gravatar of Jim Glass Jim Glass
    24. June 2012 at 11:31

    @MF,
    I think an arithmetic mean is justified for independent events like monthly rates of inflation.

    except when using a monthly year-over-year (YoY) averages, the observations are not independent. each YoY change overlaps the previous one by 11 months.

    Yes. I’d also like him to show the class his work demonstrating how he figures his 1.8% average inflation which even arithmetically adds up to 5.4% after only three years fits into only 4.3% inflation (228.527/219.090) after nearly four years.

    I mean, if he so wants to advertise his expertise maybe he can rent a billboard and put it up there.

    Face it, MF would be arguing that the Earth is banana shaped if he got it in his head that Sir Bedevere was an Austrian.
    :-)

  53. Gravatar of Major_Freedom Major_Freedom
    24. June 2012 at 11:36

    dwb:

    except when using a monthly year-over-year (YoY) averages, the observations are not independent. each YoY change overlaps the previous one by 11 months.

    Yes, that’s probably the main reason why I thought my first attempt was off and asked about average MoM changes.

    one can get significant error when using overlapping periods to estimate (unless the period is really long), never do this!

    Isn’t “really long” the correct horizon for judging inflation from the Fed? If historians look back on the period 1913-2012, and they see an average of 2.5% annual inflation, isn’t that a “success”? Or should “really long” be shorter than the average person’s lifespan? Or their career? Where do we go from arguing over personal preferences, to something more objective?

    also, by including YoY changes starting in august 2008, you are including 11 months of inflation prior to august 2008.

    Yes, I mentioned including 2007 data that way, which is another reason why the first attempt was not what I wanted to convey.

    sure, in any average one might get 45 “2%) and one -100% which skews the average. That’s why we have this other metric called the standard deviation.

    Agreed, but how often is that used with inflation estimates?

    Just consider the last 46 months “1.1% inflation” for example. The s.d. would be higher here than it was for the 46 months prior.

    if you do it the correct way using month-over-month changes instead of monthly YoY changes, then you get pretty close to the correct answer:

    average 0.09%

    compounded 1.12%

    true 1.11%

    dwb, there is no one “correct” answer for estimating the average rate of monthly inflation. They are all “correct”. Where they become different is in their subjective usefulness relative to each other.

    The “true” 1.1% you estimate is the rate that would result in the initial value mapping to the ending value by the operand of compounding 1.1% 46 times. But that’s precisely what I wanted to avoid, because I am arguing that there is too much weight being put on the initial starting value in this way. The entire estimation calculation of 1.1% depends on the initial value. If the initial 2008-07-01 CPI index is itself an “outlier”, then it will drastically change the implied annual inflation rate.

    When I look at the CPI data, I see that picking 2008-07-01 just so happens to correspond to a local peak in CPI, at a time when the YoY inflation rate at the time was over 5%.

    Is it really a surprise then that picking an initial starting value that is way above the long term inflation goal of the Fed (over 5%), after which the rate of inflation gradually came back down closer to its mandate, would result in an average estimate of 1.1% for the whole period, thus making it seem like the Fed has “failed”, even though taking a LONGER period of time, say back to 2000, using monthly changes instead, leads to an average of 2.55%?

    This is why I wanted to use the average of monthly changes.

    I abandoned the YoY monthly changes in favor of monthly changes, BTW.

    You calculated an average monthly change of 1.12%, whereas I calculated an average monthly change of 1.4%. I redid it, and yes, I get the same average as you did. I am just trying to turn a particular argument I have into numerical data. I’ve never done this particular example before.

    please, never never tell me where you (allegedly) got your MBA and who your bus stats professor was. ack!!

    Hahaha, insulting my professors, degree, school, etc, has nothing to do with the validity or invalidity of the arguments I am making here.

    At least RebelEconomist understands the point I am trying to make.

    ssumner:

    MF, I see that math is also not your strong suit. Do you even have a strong suit?

    Haha, you say that like my strong suit is not economic theory, as if I haven’t refuted you time and time again.

    Yes, math is not my strong suit, but then economics isn’t yours.

  54. Gravatar of Major_Freedom Major_Freedom
    24. June 2012 at 11:50

    “Long term inflation is consistent with the Fed’s current mandate.”

    People have drowned in lakes with an average depth of 3 feet. What you don’t understand is that inflation has been lower than average when unemployment is high and vice versa, the exact opposite of what’s needed.

    I understand that’s what YOU believe is needed. But what you believe is needed is not the same thing as the actual Fed mandate.

    What stabilizing long term consumer price inflation would look like is not the Fed bringing about higher price inflation when employment falls, and lower price inflation when employment rises.

    The Fed’s price stability mandate is not to micromanage short term employment fluctuations. Stabilizing long term consumer price inflation is not a program of micromanaging the economy’s output, or labor force. It is meant as a stabilization of the currency, OUT OF WHICH long term output and employment are expected to be maximized.

    It is NOT true that “high price inflation is needed when employment falls, and low price inflation is needed when employment rises”. That is a rather dubious way of sneaking in NGDP through the back door, as if this has always been the Fed’s mandate. No, the Fed isn’t supposed to raise price inflation when employment is low, and raise price inflation when employment is high. That belief is not only not the Fed’s current mandate, but the presupposed theory has already been empirically falsified, what with the stagflation of the 1970s, which saw rising price inflation accompanying FALLING employment, and decreasing price inflation accompanying RISING employment.

    You are just making it up when you say “The Fed needs to raise price inflation when employment falls.” Rising consumer price inflation can occur and has occurred with rising unemployment, and falling consumer price inflation can and has occurred with falling unemployment.

    Your claim on what “needs” to be done tacitly presumes that the unemployment equilibrium doctrine is somehow still valid and has not been falsified.

    The belief that higher consumer price inflation “benefits” employment is WRONG.

    This is my strength, Sumner. I can increase the quality of economic theory and discussion on this blog. I’ll leave the number crunching to others.

  55. Gravatar of dwb dwb
    24. June 2012 at 11:55

    @MF,

    fine but my suggestion would be to post after you get it right. a good rule i live by is that management only reads the first three sentences of emails, so they need to be crisp and efficient. That goes for blog posts as well.

    The Fed’s stated goal is 2% PCE. Going forward, the fact that Brent crude has dropped to $90 strongly suggests that the PCE will print at about 1.5% YoY or lower in the next few months. that means the Fed has failed at its own self-set goals.

  56. Gravatar of Major_Freedom Major_Freedom
    24. June 2012 at 11:59

    dwb:

    The official Fed target is 2% PCE, not CPI, which has averaged about 1.3% over the last 46 months.

    The official Fed target is not price inflation, but how many dollars are being spent on consumption? Really?

    OK, if we go by PCE, then the Fed since 2000 has been way above 2% target:

    http://research.stlouisfed.org/fredgraph.png?g=8dZ

    Taking the average of YoY changes since 2000, the Fed has averaged 4.5% annual growth of PCE.

    What has happened to employment since 2000?

    http://research.stlouisfed.org/fredgraph.png?g=8e0

    There is about the same amount of employment today as there was in 2000. And that is not even correcting for population growth!

    So the Fed has not only OVERSHOT its long term PCE target, (or price inflation mandate if you want to look at that), but it has also UNDERSHOT the employment target.

    Failure all around.

  57. Gravatar of dwb dwb
    24. June 2012 at 12:08

    @MF:
    2% inflation as measured by the PCE price index (PCEPI in fred)

  58. Gravatar of Joel Fish Joel Fish
    24. June 2012 at 12:13

    Okay, this is semi-related…. Would Scott’s ideal tax scheme increase investment inequality among the populace? I am concerned that because the value of investments tends to grow geometrically, reducing (or eliminating) taxes on capital would tend to separate society into working class citizens and investor class citizens. Is this a (moral? ecomic?) concern?

  59. Gravatar of Major_Freedom Major_Freedom
    24. June 2012 at 12:16

    dwb:

    fine but my suggestion would be to post after you get it right.

    And miss out on the intellectual barrage of attacks? Not a chance. That’s what makes this so much fun! I am the kind of person who is as willing taking it, as I am willing to dish it out. If anything, I argue it helps everyone.

    RebelEconomist for example can’t stand what I write, but he saw validity in what I disasterously tried to say. That’s the main goal I had. To make an argument that either makes more clear, or perhaps correct, the “1.1% for the last 46 months” claim being made.

    I mean do you think it’s really a fair representation of the long term, so pick out the single date where the CPI index was at a local peak, and the YoY price inflation was at a local peak of over 5%, to then say “Price inflation the last 46 months was 1.1%”?

    Wouldn’t it be a fairer representation to either look at monthly changes only, or, even better, include data from before that local peak, which was itself far above the Fed’s mandate anyway?

    To me alarm bells go off when the starting date just so happens to be a local above target maximum. I mean who argues average price inflation over the last 46 months, unless they INTENDED to bias the estimated price inflation to make a case for their political desires?

    Do you really think it’s a coincidence that Sumner, someone who wants more price inflation, would pick a starting date that just so happens to be a local above target peak, the resultant inflation calculation of which makes the average price inflation estimate the lowest it can possibly be? By continually repeating “1.1% inflation the last 46 months”, it clouds and obfuscates the fact that price inflation since 2000 has been 2-3%, AND is clouds and obfuscates the fact that the initial starting date was a time when price inflation was over 5%, far above the Fed’s mandate.

    a good rule i live by is that management only reads the first three sentences of emails, so they need to be crisp and efficient. That goes for blog posts as well.

    Do you actually believe that posting comments here is like posting comments to your boss? Well now it makes sense why you intellectually defer to Sumner all the time. This is an economics blog. Aren’t economics blog discussions supposed to be open, rather than so official?

    The Fed’s stated goal is 2% PCE. Going forward, the fact that Brent crude has dropped to $90 strongly suggests that the PCE will print at about 1.5% YoY or lower in the next few months. that means the Fed has failed at its own self-set goals.

    If the Fed’s stated goal is PCE, then they have been far above that target if the average is since 2000, as I showed in the above link.

  60. Gravatar of Major_Freedom Major_Freedom
    24. June 2012 at 12:27

    dwb:

    2% inflation as measured by the PCE price index (PCEPI in fred)

    OK, well that is almost identical to the CPI index:

    http://research.stlouisfed.org/fredgraph.png?g=8e5

    The PCEPI is above CPI for the entire period.

    If we go by PCEPI, then the Fed has averaged an annual PCEPI growth of 2.18% since 2000.

    That’s above the Fed’s long term target of 2%.

  61. Gravatar of dwb dwb
    24. June 2012 at 12:33

    @MF,
    you are correct in that the past is a sunk cost anyway, the expected future inflation is what is relevant. Over the next three years, inflation is expected to be well under the Fed’s goal. Actually, the Fed really only controls domestic inflation but thats another point. I am not sure either point is news to anyone.

    my point about the 3 sentence rule is that people are extremely busy and typically read about the first three sentences, and then decide if they want to read more. you can ignore my advice about being more effective, or not. i don’t actually care.

  62. Gravatar of Major_Freedom Major_Freedom
    24. June 2012 at 12:40

    Anyone who says the Fed is “supposed” to run higher price inflation when employment falls, and lower price inflation when employment rises, is:

    1. Advocating the Fed micromanage the economy; and/or

    2. Believes in the empirically falsified unemployment equilibrium doctrine; and/or

    3. Is tacitly making the normative case that the Fed “ought” to be targeting nominal spending, which is actually independent and separate from the Fed’s actual (current) mandate of price stability.

    No, the Fed does not and cannot increase employment by bringing about more price inflation, so the “employment mandate” part of the Fed’s “dual mandate” is not brought about by higher price inflation, either in theory or empirically.

  63. Gravatar of Shane Shane
    24. June 2012 at 12:48

    @ Joel,

    Arguably yes, which is why the left-progressive versions of consumption taxes (advocated by Robert Frank, Matt Yglesias, et al.) usually feature wealth and inheritance taxes, which Dr. Sumner’s doesn’t. Though he would argue (I believe) that the better solution to inequality is to redistribute consumption through wage and benefit subsidies, thus avoiding the distortionary effects of wealth and inheritance taxes.

  64. Gravatar of Major_Freedom Major_Freedom
    24. June 2012 at 12:48

    dwb:

    you are correct in that the past is a sunk cost anyway, the expected future inflation is what is relevant.

    Oh really? I got my head bit off repeatedly for suggesting that. I was told “LEVELS! MF! LEVELS!” which is a tacit advocacy for “worshiping the past”, so to speak.

    Over the next three years, inflation is expected to be well under the Fed’s goal.

    Please don’t tell me that you’re getting this information from the yields or yield spreads of TIPS. If you do, then I’ll have to chalk up you along with Krugman, Sumner, and their acolytes as also having no clue how the TIPS market and TIPS pricing works.

    Maybe you missed the discussion before, but:

    A lower TIPS yield, or lower TIPS yield spread, does not necessarily signal decreasing inflation expectations. It could just as well signal the opposite, as the embedded call option premium on the TIPS increases as expectations on future inflation increases. When that embedded call option increases in value due to expected inflation increasing, it decreases the yield on the TIPS bond. Investors can be willing to incur low current yield, if they expect future yield to increase due to increasing inflation down the road.

    Then there is also the fluctuating value of the embedded put option on the guaranteed principle, which does not exist in other inflation hedges like gold futures, and the result is that we cannot infer from TIPS yields, or TIPS spreads, any particular inflation expectation, up or down.

    my point about the 3 sentence rule is that people are extremely busy and typically read about the first three sentences, and then decide if they want to read more. you can ignore my advice about being more effective, or not. i don’t actually care.

    I don’t think people on this blog are all that busy.

  65. Gravatar of dwb dwb
    24. June 2012 at 13:01

    @MF,

    you are all wrong about TIPS there is no call option, there is a put option, but since the CPI has printed higher since most TIPS were issued, the option has very little value (check it on a Bloomberg terminal). Since you think the TIPS is wrong make your call. my call is that PCEPI prints lower than 1.5% over the next year, as measured starting with the april 2012 PCE index of 115.637. The release is June 29.

  66. Gravatar of Major_Freedom Major_Freedom
    24. June 2012 at 13:30

    dwb:

    you are all wrong about TIPS there is no call option, there is a put option, but since the CPI has printed higher since most TIPS were issued, the option has very little value (check it on a Bloomberg terminal).

    Aaaaaaand I was right. You also have no clue how the TIPS market works.

    Yes, there is in fact an embedded call option in TIPS bonds. The future cash flows on TIPS bonds are a function of future inflation, which is a priori uncertain. Hence, when investors buy a TIPS bond, they are buying a call option on those future cash flows, where the price paid “pays off” if the discounted future cash flows is greater than the current low (or even negative) yield.

    In other words, if you are willing to pay $10 if it means you can get $100 next year, then you should be able to understand how current low yields on TIPS bonds MAY signal higher expected inflation.

    Since you think the TIPS is wrong make your call.

    I am not making the claim that TIPS “is wrong.” There is no “right” and “wrong” here.

    I am saying the information you believe is communicated by TIPS yields and/or yield spreads is not the case.

    I hold that falling TIPS yields and/or yield spreads does not necessarily communicate falling inflation expectations. It could mean that, but it could mean the opposite.

    my call is that PCEPI prints lower than 1.5% over the next year, as measured starting with the april 2012 PCE index of 115.637. The release is June 29.

    I don’t know what the PCEPI will be one year from now, because the Fed could always announce and enact a new QE program, or they could do what they did in mid 2008, which is allow M2 growth to fall to barely 1%, from a previous recent high of over 10%.

    I go by aggregate money supply growth, and for the last 3 months, (annualized) M2 growth is at 4.4%, and has been falling over the last year fro a high of almost 10%.

    You are all wrong about TIPS bonds having no embedded call option.

  67. Gravatar of Major_Freedom Major_Freedom
    24. June 2012 at 13:55

    dwb:

    “since the CPI has printed higher since most TIPS were issued, the option has very little value”

    Existing TIPS are constantly traded, and new TIPS are constantly issued.

    If you compare all TIPS denominations, 5, 10 and 30 year:

    http://research.stlouisfed.org/fredgraph.png?g=8e7

    We see a general decline in yields. The relatively low call option value that seems to suggest low expected inflation to you, shows that TIPS bond yields of all maturities are declining in the same way.

    Would you at least accept the possibility that the declining yields in TIPS bonds which won’t mature for many years, MAY signal higher future expected inflation, because there at least the call options could be more relevant in the current yields?

    I see a general decline for all maturities.

  68. Gravatar of dwb dwb
    24. June 2012 at 13:57

    @MF,

    you dont know what a call option is. A put or call option has asymmetric payoff. TIPS has a put option because the payoff is max(par=100, CPI-adjusted principal). There is no call option. what you are asserting as a call option is in fact known as a liquidity premium, which is historically worth between 30 and 60 bps (depending on term and maturity). my advice is that if you think they are mispriced, 1) take your theory to the trading desk; b)bet accordingly (there are also inflation swaps you can trade). no need to debate this, call me in 1 year. my bet is that the PCE prints below 1.5% over the next year. whats your bet?

  69. Gravatar of Major_Freedom Major_Freedom
    24. June 2012 at 14:08

    Regarding that last graph, do you actually believe that investors believe inflation for the next 30 years (or somewhat less depending on when the 30 years were issued), is going to be 0.5%???!?!?

    That’s crazy.

  70. Gravatar of RebelEconomist RebelEconomist
    24. June 2012 at 14:21

    @dwb, “The official Fed target is 2% PCE, not CPI, which has averaged about 1.3% over the last 46 months”

    This has only been “official” for the last five months, and then I would say that the change to PCE was yet another fiddle to relax the inflation target, because over the long run PCE tends to read a few tenths below the CPI because of methodological differences (essentially, because the PCE consumption basket is updated more often).

    Moreover, the Fed’s “longer run goals and policy strategy statement” of January 25 2012 which introduced this target for PCE also said that “it would not be appropriate to specify a fixed goal for employment”, so there is no official Fed target for employment. You can’t have it both ways!

  71. Gravatar of dwb dwb
    24. June 2012 at 14:46

    @RebelEconomist,
    yes, fair enough, the target has only been “official” for 5 months, and the committee cannot agree much else these days. I dont know how much CPI or PCE overstates inflation, i have not seen a recent study on it.

    @MF,
    inflation over the next 30 years as implied by TIPS is expected to be 2.18%.

    there is no call option. i don’t feel like debating any more i am headed off to enjoy the rest of my sunday. if you think your silly ideas are correct, my advice is to write to Fabbozzi and Hull/White, ask them to revise their texts. There are a plethora of bank and trading models to revise as well so the Fed/OCC will be interested too. Oh and Bloomberg. you can send queries to the help desk. Before you do that my advice is to start a hedge fund, or join one, since there are about 2000 of them who might be interested in your ideas. you can actually trade some inflation call options and swaps against that TIPS call option if you think there is one and make some cash.

  72. Gravatar of dwb dwb
    24. June 2012 at 14:54

    oh and the CFA exam too. call them

  73. Gravatar of Major_Freedom Major_Freedom
    24. June 2012 at 14:55

    As for TIPS spreads:

    http://research.stlouisfed.org/fredgraph.png?g=8ef

    I don’t think the rising spread necessarily signals rising inflation expectations, nor that falling spread necessarily signals falling inflation expectations.

  74. Gravatar of Bill Ellis Bill Ellis
    24. June 2012 at 14:59

    S. Sumner says…

    Actually, forget about the public, I’d estimate that half the economists I talk to don’t understand that taxes on capital are double taxing the same wage income.

    I don’t get this. Are you saying Mitt paying 14 % is the same as my household paying 28 % ? (Does that mean when we start drawing on our 401ks that will will actual be being taxed at twice the normal rate ?)

    I bet the answer will go over over my head, But would anyone like to give it a shot ?

  75. Gravatar of Major_Freedom Major_Freedom
    24. June 2012 at 15:02

    dwb:

    there is no call option.

    Yes, there is an embedded call option.

    i don’t feel like debating any more i am headed off to enjoy the rest of my sunday.

    I suggest you spend the rest of your Sunday researching TIPS bonds.

    if you think your silly ideas are correct, my advice is to write to Fabbozzi and Hull/White, ask them to revise their texts.

    They’re not silly. My Hull/White edition precedes the invention of TIPS bonds. What do they say in their latest edition?

    There are a plethora of bank and trading models to revise as well so the Fed/OCC will be interested too. Oh and Bloomberg.

    These are all just sources for prices, issues, and bonds outstanding.

    you can actually trade some inflation call options and swaps against that TIPS call option if you think there is one and make some cash.

    Investors are already doing that.

    See the work of Jacoby and Shiller (2008), The Journal of Fixed Income, Fall 2008, Vol. 18, No. 2: pp. 71-84.

    I don’t understand why your mind is so antagonistic to what is so common and intuitive.

    Is it really only because you need TIPS yields to signal some sort of market based justification for more inflation? Please tell me that’s not it. Please tell me it’s more than that.

  76. Gravatar of Lars Christensen Lars Christensen
    24. June 2012 at 15:03

    Let me ask again – do Internet Austrains believe in the market or not and then tell me what the market is teling us about the inflation? Major Freedom feel free to answer?

  77. Gravatar of Joe Joe
    24. June 2012 at 15:08

    MF makes me miss Morgan….

  78. Gravatar of Major_Freedom Major_Freedom
    24. June 2012 at 15:12

    dwb:

    oh and the CFA exam too. call them

    Level I deals with pricing synthetic securities. I would imagine the latest CFA courseware contains a discussion on how a TIPS bond can be priced by pricing a synthetic security consisting of a vanilla bond plus a call option.

    The market for TIPS bonds contains quite a diverse set of investor expectations. It’s not homogeneous. For the subset of investors who are worried about inflation, buying a TIPS bond can act as an alternative to buying a vanilla bond and a call option on inflation.

  79. Gravatar of John Thacker John Thacker
    24. June 2012 at 15:16

    Bill Ellis,

    You are making the mistake I mentioned if you compare your marginal 28% federal rate to Romney’s average federal rate on all income.

    In any case, I don’t see why you would want a tax system that rewards rich people for spending money and consuming resources like the worst image of Paris Hilton, while punishing them for living frugally and directing the world resources towards what other consumers want.

    I suppose rich people spending money on purely positional goods is relatively better, but those do have value.

  80. Gravatar of Major_Freedom Major_Freedom
    24. June 2012 at 15:20

    Lars Christensen:

    Let me ask again – do Internet Austrains believe in the market or not and then tell me what the market is teling us about the inflation? Major Freedom feel free to answer?

    After debating internet Monetarists, and internet Keynesians, and internet everybody whose arguments are moot because they’re being made on the internet…

    The “market” for TIPS securities, the yields, the yields spreads, do not necessarily communicate what so many people on this blog are assuming it communicates.

    The market is telling us something yes, but I argue that falling yield spreads does not necessarily communicate to us falling inflation expectations. It COULD mean rising inflation expectations, and it COULD mean falling inflation expectations.

    Your desire to know what “the market” is saying doesn’t entitle you to just assume that TIPS yields directly communicate it one way or the other. The strong desire to know what to expect is no substitute for what expectations actually are.

    In truth, there is no “market” expectation of inflation. SOME investors expect higher inflation than X%, while OTHER investors expect lower inflation than X%. For those investors who expect higher future inflation, they might pay a higher price for a TIPS bond and thus lower their yield. Or, they might just buy a vanilla bond and hedge inflation in some other way. There’s no way to tell from the yields alone what market expectations of inflation are.

    I already got Kevin Dick to admit this, and he’s an internet monetarist.

    There is no one market expectation. There are as many expectations as there are individual investors.

    MF makes me miss Morgan….:

    Burn!

  81. Gravatar of Joe Joe
    24. June 2012 at 15:21

    Love

  82. Gravatar of Major_Freedom Major_Freedom
    24. June 2012 at 15:45

    dwb:

    you dont know what a call option is.

    I can assure you I know what it is.

    You don’t know that a TIPS bond contains an embedded call option for inflation.

    A put or call option has asymmetric payoff. TIPS has a put option because the payoff is max(par=100, CPI-adjusted principal).

    Right. But there is also a call option on the inflation component, because one could make a synthetic security consisting of a vanilla bond plus a call option on inflation.

    There is no call option.

    Yes, there is.

    what you are asserting as a call option is in fact known as a liquidity premium, which is historically worth between 30 and 60 bps (depending on term and maturity).

    No, the liquidity premium is something else entirely. That is something common to bonds in general.

    I am talking about paying a premium that pays off when future inflation increases beyond the yield on the vanilla equivalent. That is an asymmetric payoff as well.

    my advice is that if you think they are mispriced, 1) take your theory to the trading desk;

    I don’t think they’re “mispriced.” Again, you keep missing the point of my argument on the basis of your confusion regarding what rising and falling TIPS yields is supposed to communicate. You refuse to deviate from the notion that falling spreads signals falling inflation expectations and rising spreads signals rising inflation expectations, and so you mistakenly believe that my argument that falling spreads MAY signal rising inflation expectations, is somehow a claim that TIPS are “mispriced”.

    b)bet accordingly (there are also inflation swaps you can trade). no need to debate this, call me in 1 year. my bet is that the PCE prints below 1.5% over the next year. whats your bet?

    I am not making a bet. I am not saying TIPS bonds are currently mispriced! Prices on TIPS bonds are based on subjective valuations, not actual inflation.

    The future payoff on TIPS bonds depends on the current subjective valuation of the TIPS bonds. If inflation rises in the future, it doesn’t necessarily mean TIPS spreads will rise, and inflation falling in the future doesn’t mean that TIPS spreads will fall. Each day’s pricing depends on subjective valuations.

    As for what I expect for inflation, I won’t get any market based expectation from TIPS spreads.

  83. Gravatar of Robert Robert
    24. June 2012 at 15:53

    MF,

    I don’t see any explanation in there for why the zero arbitrage condition might not hold. Of course there are many investors with many expectations. But if some investors have more confident expectations than others then there is arbitrage to be made. The point isn’t that there is one entity called “the market” which has expectations; the point is that “the market” can extract the most accurate forecasts from the multitude of individuals. So do you have a reason that this might not hold?

  84. Gravatar of Major_Freedom Major_Freedom
    24. June 2012 at 16:09

    Robert:

    I don’t see any explanation in there for why the zero arbitrage condition might not hold.

    I don’t see how anything I am saying requires zero arbitrage to not hold.

    If an investor can choose between a vanilla bond plus a call option that pays off with inflation, and a TIPS bond alone, where is there any assumption for non-zero arbitrage?

    Of course there are many investors with many expectations. But if some investors have more confident expectations than others then there is arbitrage to be made.

    How does any investor know how psychologically confident any other investor is? Each investor has their own expectation, which is of course shaped by existing prices, but it doesn’t mean arbitrage can be made in what I am saying.

    The point isn’t that there is one entity called “the market” which has expectations; the point is that “the market” can extract the most accurate forecasts from the multitude of individuals. So do you have a reason that this might not hold?

    I am saying that forecasts for inflation you think are communicated by TIPS spreads, are not necessarily communicated by TIPS spreads. That’s all. The same information can signal opposite inflation expectations.

    I cannot see, and maybe you can enlighten me, how falling TIPS spreads possibly signalling higher future inflation expectations, can lead to arbitrage opportunities. Which two synthetically identical markets are mispriced relative to each other?

  85. Gravatar of Major_Freedom Major_Freedom
    24. June 2012 at 16:19

    In other words, if I and a few other investors expected higher inflation than other investors, and I was willing to pay a premium to buy a TIPS bond, then would it be impossible for me to make money doing this?

    Similarly, if I and a few other investors expected lower inflation than the rate on vanilla bonds than other investors, and I was willing to accept the current low yield spread on a TIPS bond, then would it be impossible for me to make money doing this?

    If I did go out and but a TIPS bond then, how can you infer from my bid price alone that I expect higher or lower inflation in the future?

  86. Gravatar of ssumner ssumner
    24. June 2012 at 17:14

    Saturos, That would help a little bit.

    John Thacker, I agree.

    Tom Kelly, You said;

    “And obviously gas is way up.”

    Actually, gasoline prices haven’t increased at all in the last 46 months. And natural gas prices are down. And housing is much cheaper—a far more important trend then the haircuts, etc, you mention.

    Lars, I agree.

    Saturos, Yes, I met him recently in Kansas City.

    Rebeleconomist, I certainly agree that poll numbers are not reliable. You said:

    “Now since the Boskin committee introduced methodological reforms from about 1996 that lowered the measured rate of inflation by about 3/4%, a measured rate of 1.1% in the last four years is about on target.”

    This is a complete non sequitor. The question of which inflation number is “correct” has nothing to do with the question of whether money is too easy or tight given the Fed’s current policy regime. In fact, it’s very tight given the Fed’s policy regime. Whether they should have a different policy regime (due to the Boskin findings) is a completely separate question.

    David, You said;

    “It seems you are saying that the public should like (or a priori does like?) demand-side inflation.”

    No that is no my claim. I’m claiming they like it more than the alternative, but only when demand stimulus is needed.

    The Indian case supports my point. They’ve had a negative supply shock, so naturally the India people are unhappy. No monetary policy can change that fact.

    D. Gibson. To the extent that education is investment and not consumption, it should be excluded from any VAT. I’d add that education is hugely subsidized in virtually all countries, so in practicce we tax income from physical capital higher than income from human capital.

    Shane, You said;

    “I think utilitarians should avoid the double taxation argument altogether; indeed, it is almost always deployed in a highly selective, highly misleading way in order to make it seem morally suspect to impose a tax that will fall disproportionately on the wealthy.”

    I would claim Buffett pays no tax at all, in the sense that lower taxes would not lead him to reduce his consumption. The problem with taxes on the rich is that the burden often falls on to some other group. If you tax high levels of consumption at higher rates, then you have truly imposed a burden on the wealthy—but not otherwise.

    Joel, I favor the sort of fiscal regime they have in Singapore, which leads the vast majority of people having much more wealth than otherwise. Admitedly there is substantial inequality there, but that’s misleading because they have immigrant workers do the bad jobs that the rich locals don’t want to do. And those immigrants are much better off than if they’d stayed in their home country. We should focus more on making everyone richer, and less on inequality.

    Shane, A consumption tax is a wealth tax done correctly–they are the same in principle. Wealth is the present value of future consumption.

  87. Gravatar of dwb dwb
    24. June 2012 at 17:44

    @MF,
    I have seen that paper you are misreading it.

    no: Jacoby and Shiller (2008) does not imply there is both a put and a call option. Any put option can be transformed into a call option plus a short position and a risk free bond (put-call parity). This is just a clever application of put-call parity for discount bonds (see page 73, “valuing a tips bond” where they mention it). That does not imply that there is both a put and a call option (the equivalent statement for a stock would be that i can replicate a put option on MSFT by shorting the stock and buying a call). Also, you cannot use this to ascertain the actual value of the option since they use black-scholes (technically i think this is black-karasinski) and this only applies to discount bonds.

    Don’t take my word for it, if you dont believe me, write the authors and ask them.

  88. Gravatar of SG SG
    24. June 2012 at 18:16

    @ Major Freedom:

    You take the position that you cannot infer a market forecast of inflation from TIPS spreads against vanilla treasury bonds…

    But if you knew that inflation would be higher or lower than than the current spread, wouldn’t that create an opportunity for costless arbitrage?

  89. Gravatar of Mark A. Sadowski Mark A. Sadowski
    24. June 2012 at 18:21

    dwb,
    You wrote:
    “so, no, not achieving 2/3 of its objectives.”

    Or none.

    If the “moderate” mandate on long run interest rates is interpreted as being symmetric then a 10-year rate of 1.7% could hardly be interpreted as bing moderate. If the FOMC were meeting its goals then a rate of 5% (2% inflation plus say a 3% natural real rate) would be more like it. So I would argue the FOMC is currently meeting none of its objectives.

    P.S. On the subject of the unemployment rate I would argue that based on the FOMC’s long run central tendency for unemployment that their implicit target is currently 5.6%. This is slightly higher than the CBO’s estimate of 5.2% for the natural rate of unemployment.

  90. Gravatar of dwb dwb
    24. June 2012 at 18:47

    @Mark A. Sadowski

    ok i stand corrected, not meeting 3/3 objectives. if low rates were the solution we would be having the biggest boom in history.

    “On the subject of the unemployment rate I would argue that based on the FOMC’s long run central tendency for unemployment that their implicit target is currently 5.6%.”

    maybe, depends on whether you believe their forecast or their actions. i think their implicit target is 4.5% nominal growth, and their models suggest any more would be inflationary, and they remain fanatically opposed to inflation above 1.75%.

  91. Gravatar of Shane Shane
    24. June 2012 at 19:59

    Dr. Sumner, you said: “I would claim Buffett pays no tax at all, in the sense that lower taxes would not lead him to reduce his consumption.”

    Even if true for all wealthy individuals, which is doubtful, this has nothing to do with double taxation. It would also be true of a system with no income or payroll tax and a capital gains tax. The double taxation argument is a rationalization, much like the “flat tax has no deductions and is simpler–true of progressive payroll taxes as well, and hence disingenuous.

    As for your claim that, “Wealth is the present value of future consumption”–this is, as you note, only true if we consider charity and bequests as consumption. But that seems like a highly odd definition. If you have no objections to taxing consumption first as wages and then through a VAT, what then is wrong with double taxing this type of consumption first as wages and later as a gift/inheritance tax? Or triple taxing it by throwing in capital gains? If it doesn’t make sense to consider them consumption, shouldn’t they be totally exempted from consumption taxes, as in the Fair Tax, Robert Frank versions, etc.?

  92. Gravatar of Matt Waters Matt Waters
    24. June 2012 at 20:01

    “In other words, if I and a few other investors expected higher inflation than other investors, and I was willing to pay a premium to buy a TIPS bond, then would it be impossible for me to make money doing this?”

    No. Go short TIPS bonds. Go long non-inflation indexed Treasuries. If you go short and long the same amount, then the positions essentially cost you nothing.

    MF, you seem pretty convinced of your position, but I’ll give you a pro tip. If the market says one thing and you say another, you should examine your position very closely. The “market” is not some mystical outside force. The market is the consensus of real people with real money riding on the market’s predicted outcome.

    In some cases, the market can in fact be wrong (see my comment on the old CNBC post). But that’s certainly the exception, not the rule. If you throw a dart on a WSJ stock listing, you are very unlikely to find a stock that’s significantly overvalued or undervalued based on all publicly available information.

    Meanwhile, the Treasury market and TIPS spread market are far more liquid and open than the market for most stocks. So why are two of the most heavily traded markets so wrong in this case? So far, you have presented evidence that TIPS spreads of 1% are wrong because inflation the last three years has…averaged 1% geometrically (the same way TIPS incorporate inflation). After the figures, it’s a just a bunch of baseless conjecture.

  93. Gravatar of Matt Waters Matt Waters
    24. June 2012 at 20:17

    Well, first, I got the arbitrage wrong. You go short non-inflation Treasuries and long TIPS. This is counter-intuitive to how I usually understand bond prices, which is why I got the trade wrong. Nevertheless, the point stands that MF could easily make money off of his predictions.

    Just to be make my point clearer, let me respond specifically to this point:

    “The future payoff on TIPS bonds depends on the current subjective valuation of the TIPS bonds. If inflation rises in the future, it doesn’t necessarily mean TIPS spreads will rise, and inflation falling in the future doesn’t mean that TIPS spreads will fall. Each day’s pricing depends on subjective valuations.”

    You are seriously confusing the issue here. A TIPS bond is not intrinsically worth what a TIPS bond will be priced in the future. The intrinsic worth of a TIPS bond actually has nothing to do with its current price.

    Instead, a TIPS bond is worth the discounted value of future cash flows. Not future price movements, but the cash that physically transferred from the Treasury to you because you own a TIPS bond.

    So, let’s say you are right that inflation will be significantly higher in the future. You can then go short a Treasury that will yield 2% for 10 years and go long a TIPS bond that will yield 2% plus the CPI for that year.

    The TIPS bond already trades at a premium because it is expected to yield 1% more money per year than the Treasury. If you are right though, then that premium is not worth the actual cash flows the Treasury will have to pay out. The actual CPI will be higher than expected over the next 10 years.

    If you are right, then you will get a positive return on this trade REGARDLESS OF WHAT THE PRICE DO. Sorry for the caps, but the main point with arbitrage trades. Look up the put-call arbitrage formula. It says nothing about what puts or calls will do in price until expiry. It just says that the investor will lock in cash flows on zero principal if put-call parity is not met.

    In the case of TIPS spreads, if you are right then you can risk very little of your money (because the money from the Treasury short covered most of the cost of going long TIPS) to get an outsize return in the form of Treasury interest payments. If you can do this, then the market is wrong. The market should not leave easy outsize returns on the table.

    So, again, if you say TIPS spreads underestimate inflation, you are saying that the market is wrong. TIPS spreads cannot be wrong while the market is correct.

  94. Gravatar of Matt Waters Matt Waters
    24. June 2012 at 20:19

    Well, “REGARDLESS OF WHAT THE PRICE DO” is quite embarrassing. Where’s that green line in Word when you actually need it?

  95. Gravatar of Morgan Warstler Morgan Warstler
    24. June 2012 at 20:45

    The fed has a 2% inflation rate since recently,before that the STATED PLAN was “opportunistic disinflation” where inflation pushed down under 2%.

    Scott knows this, he just likes to pretend it isn’t true.

    He also doesn’t like to count 2% inflation from 2000, wherein the fed OWES US inflation under 2% from 2008 onward, and ha been making good.

    —–

    Count me a another who thinks the price level is bullshit, just understand that when I go along with the discussion I expect the use a definition of Price Level that has no room for padding.

  96. Gravatar of Joel Fish Joel Fish
    24. June 2012 at 20:50

    @Scott: Thanks. I’ll look into the Singapore model; and I agree that we should be first looking for ways to make people richer in general, but gross inequality still makes me nervous. I was recently wondering if a tax on real capital gains which was used *only* for the purpose of encouraging savings/investment among the middle and lower class would have a net distortionary effect on savings.

    @Shane: Thanks. I’ll check out Frank’s and Yglesias’ perspectives. I like your point about double-taxation, but I’ll guess that Scott wants to avoid taxes on capital at all costs, since such taxes discourage investing. Has he said previously that gifts and/or inheritance should be regarded as consumption?

  97. Gravatar of Lars Christensen Lars Christensen
    24. June 2012 at 20:59

    MF, okay lets forget TIPS. How about gold prices? The dollar? 10y-UST yields? S&P500? The signal is the same everywhere – US monetary conditions is becoming tighter. This is what the MARKET is telling us. Is that market wrong? Maybe – the market is often wrong, but not consistently wrong. To me it is very simple – there is no indicators – financial, monetary or macroeconomic that show any sign of increased inflationary pressures in the US economy. Rather nearly all indicators at the moments show quite clear deflationary tendencies.

  98. Gravatar of Saturos Saturos
    24. June 2012 at 21:09

    Scott, ahhh, that explains it…

    you said, “We should focus more on making everyone richer, and less on inequality.”

    I was almost beginning to worry you didn’t believe that.

    MF, so the price of computers doesn’t reflect the “market value” of that resource? Of course strictly all values are individual – that doesn’t mean it isn’t useful to say what the “market” thinks. Go ask Bob Murphy if you don’t believe me. Also, with EMH forecasts, the important thing is not just what the people trading at that price forecast but what everyone who isn’t trading (but could be) forecasts. Everyone who thinks it’s undervalued is buying, everyone who thinks it’s overvalued is selling, some people are hedging or cashing in for liquidity – but all the people staying out of the market implicitly believe there are no arbitrage profits to be made. That is what we call a “market” forecast – and the question is whether that is better than the predictions of any lone expert or central planner (I say yes).

    dwb, I see you’ve never talked to schizophrenics before.

  99. Gravatar of Benjamin Cole Benjamin Cole
    24. June 2012 at 21:37

    Excellent post.
    Try asking the public do they like spending $3,333 per resident (man, woman and child) every year on the defense, homeland security and VA complex. That is a real number. And next year even more.

    So when a family of four sits down, $13,000 is taken off the table and given to defenses, broadly defined. When we face no major enemies.

    People forget the very first session of Congress refused to give President Washington an Army. They detested standing militaries. We had just been occupied by the British, in a war we could have lost .They still did not want a standing military. In the second session, they gave Washington 1500 men to fight Native Americans.

    It’s all in how you ask the question.

  100. Gravatar of Daniel Daniel
    24. June 2012 at 23:15

    you’ll probably never get to this in comments, and i don’t see how anyone with enough attention to give would. how do you feel about the julian assange case? what does this mean for social policy in a neoliberal world? did you ever think about the chomsky critique of american policy that includes big government? i recall you during one post considering american position’s as the bad guy. not saying you think of america as a bad guy im just curious how a pragmatic libertarian handles a computer hacker that exposes state secrets?

  101. Gravatar of Daniel Daniel
    24. June 2012 at 23:17

    correction, i recall you considering Noam Chomsky’s critique of american policy as, we are the bad guy. no quotes

  102. Gravatar of RebelEconomist RebelEconomist
    25. June 2012 at 01:01

    Scott, we are talking at cross-purposes. I am making the point that over the last four years the Fed has kept inflation roughly on what the target HAS BEEN (ie for 90% of that time a pre-Boskin CPI of 2%). With the current target, representing a considerably higher rate of true (as opposed to measured) inflation than the old target, having been in place for just five months, it is hardly surprising that the Fed is below the new target on a four year view. If you want to judge the Fed’s performance against its CURRENT target by inflation observations(as opposed to TIPS breakeven rates), there is simply not enough data yet.

  103. Gravatar of Major_Freedom Major_Freedom
    25. June 2012 at 04:44

    dwb:

    no: Jacoby and Shiller (2008) does not imply there is both a put and a call option.

    dwb, are you sure you’re looking at the right paper? Because in the Jacoby and Shiller (2008) paper, they argue:

    “In terms of pricing, the inflation adjustment scheme implies that a long position in a pure-discount TIPS bond is equivalent to a long position in an unadjusted (nominal) Treasury bond and a long position in a European call option written on a fully adjusted (real) pure-discount riskless bond. This implies that, if in total the CPI increases over the life of the bond, at maturity the bondholder will exercise the call option and swap the nominal bond for the upward-adjusted principal of the real bond. On the other hand, in case of deflation over the life of the bond, the call will expire worthless, leaving the bondholder with the unadjusted principal payment of tbe nominal bond.”

    Maybe you downloaded the wrong paper?

  104. Gravatar of dwb dwb
    25. June 2012 at 05:03

    @MF,
    very sure. read the next paragraph starting with alternatively, and the paragraph on the next page “value of a tips bond” with foot note 4.

  105. Gravatar of Major_Freedom Major_Freedom
    25. June 2012 at 05:25

    Matt Waters:

    No. Go short TIPS bonds. Go long non-inflation indexed Treasuries. If you go short and long the same amount, then the positions essentially cost you nothing.

    Matt, I am not saying TIPS bonds are “mispriced”!

    Again, what I am arguing is that from the price I do observe, I cannot INFER from that price whether or not investors expect higher inflation or lower inflation down the road, that would possibly differ my expectation, such that I can make a return by shorting or longing the “mispriced” TIPS bond.

    You’re not getting my argument.

    MF, you seem pretty convinced of your position, but I’ll give you a pro tip. If the market says one thing and you say another, you should examine your position very closely. The “market” is not some mystical outside force. The market is the consensus of real people with real money riding on the market’s predicted outcome.

    My argument is precisely that “the market” is NOT saying what you believe it is saying by way of TIPS yields and TIPS yield spreads!

    I am not saying “The market is saying one thing about inflation but I believe inflation will be another thing.”

    I am saying if TIPS spreads fall, then you cannot infer from this that “the market” is expecting falling inflation. That’s it. That’s all I am saying. I am saying it COULD mean increasing inflation expectations OR it COULD mean decreasing inflation expectations. It doesn’t necessarily mean falling inflation expectations, because of the embedded call and put options, as well as other factors, complicating the issue.

    Saturos:

    MF, so the price of computers doesn’t reflect the “market value” of that resource?

    Yes, it does.

    Again, I am not saying TIPS spreads are “mispriced.” I am only saying that they are not communicating what you believe they are communicating. I am saying your one-dimensional interpretation of TIPS spreads (and hence TIPS prices) is not right. I am saying that you cannot say “the market expects falling inflation” on the basis of observing the TIPS spread or TIPS yield declining.

    I am not saying TIPS bonds are mispriced. I am not saying the market is wrong. I am not saying TIPS investors are wrong.

    I am saying that the popular interpretation of TIPS prices, THAT is wrong. I am saying actual TIPS investors MAY be expecting higher inflation which is manifested in you observing a fall in TIPS spreads. Or, it could mean investors expect higher inflation.

    Essentially what I am saying is “Never reason from a TIPS spread change.”

  106. Gravatar of Major_Freedom Major_Freedom
    25. June 2012 at 05:36

    Lars Christensen:

    MF, okay lets forget TIPS. How about gold prices? The dollar? 10y-UST yields? S&P500? The signal is the same everywhere – US monetary conditions is becoming tighter.

    Yes, this is a better way of thinking. Include more information, and don’t just rely on TIPS spreads.

    I hold that the optimal approach to inferring information from prices is in accordance with “mosaic theory”. Build a story, and don’t just single out TIPS spreads and say “Ergo investors expect falling price inflation.”

    This is what the MARKET is telling us. Is that market wrong? Maybe – the market is often wrong, but not consistently wrong. To me it is very simple – there is no indicators – financial, monetary or macroeconomic that show any sign of increased inflationary pressures in the US economy. Rather nearly all indicators at the moments show quite clear deflationary tendencies.

    I agree. I also include aggregate money supply data, and M2 growth has reduced from nearly 10% about a year ago, to 4.4% annual growth the last three months.

  107. Gravatar of Major_Freedom Major_Freedom
    25. June 2012 at 05:56

    dwb:

    very sure. read the next paragraph starting with alternatively, and the paragraph on the next page “value of a tips bond” with foot note 4.

    Alternatively?

    Their model for pricing the bond using call option does not depend on a put option, so your claim that the call option depends on the put option feature, is wrong. There is no put option required to price the TIPS bond using a vanilla bond plus a call option.

    Yes, they ALSO price the TIPS bond using a put option, but that doesn’t mean my argument that a call option is embedded is wrong!

    My point was that there is a call option embedded in a TIPS bond. You simply must accept this.

    ——

    My additional claim that there is also a put option embedded in the TIPS bond is actually not out directly out of the Jacoby and Shiller paper. I just cited that paper to show you that, contrary to your claim, there is an embedded call option feature in TIPS bonds.

    It is not an argument against this to say “Yeah, but they ALSO price it out using a put option!”

    ——

    At any rate, the put option feature I am talking about is actually not out of the JS paper. The put option feature I am talking about is based on the guaranteed principle. In the JS paper, they model it by a put option on a “real pure-discount riskless bond”. The “real” should clue you in that here they are talking about inflation adjustments, which are not actually riskless, because future inflation is uncertain. The put option model is actually just theoretical. The call option model is more real world.

    So my argument is call option as per JS, plus put option separate from JS. So yes, it’s call AND put.

  108. Gravatar of Major_Freedom Major_Freedom
    25. June 2012 at 06:00

    dwb:

    I said: “In the JS paper, they model it by a put option on a “real pure-discount riskless bond”.”

    Just to be clear, by “it” in “they model it”, I am referring to the TIPS bond, not the guaranteed principle.

  109. Gravatar of John Becker John Becker
    25. June 2012 at 06:07

    Scott,

    I’ve read your old posts and understand the reasons why you think that higher inflation is needed when there’s a weak economy: sticky nominal wages, debt contracts, expectations, liquidity traps, etc.

    I think economists overlook one simple fact about disinflation or falling prices during a recession. They probably overlook this because it is so simple it seems suspect. The fact is this: LOWER PRICES CAUSE PEOPLE TO BUY STUFF. There’s no denying this fact and when incomes fall it helps people if prices fall as well.

    Of course it would help if wages fell as well. Even if wages were nominally stick in a free labor market (which we don’t know because we don’t have), using inflation to reduce real wages is suspect because many people aren’t that stupid. Labor Unions have economists as well.

    What surprises me about the sticky wages argument is the fact that many economists are highly interventionist and have no problems recommending all kinds of obscene interventions in the market economy like the 2008 bailouts. Somehow you never hear them advocating government interference or even just non-coercive encouragement to BRING WAGES DOWN during a contraction. Why won’t economist recommend attacking the problem of wages being too high relative to other prices directly instead of trying to fool people through inflation? Inflation has far greater unintended consequences.

  110. Gravatar of Major_Freedom Major_Freedom
    25. June 2012 at 06:12

    John Becker:

    Excellent comment.

  111. Gravatar of dwb dwb
    25. June 2012 at 06:16

    No, you clearly don’t understand put call parity and you are misreading the paper. You can either price the option as an unprotected nominal bond plus a call option, or a long real bond plus a put option. In the first case, “if the CPI increases over the life of the bond, at maturity the bondholder will exercise the call option and swap the bond for the upward-adjusted principal of the real bond. On the other hand, in the case of deflation… the call will expire worthless. “.

    In the second case:
    “in case of deflation … the bondholder will exercise the put option and swap the real bond for the unadjusted principal of the nominal bond.”

    These are two equivalent treatments, but there is not BOTH a simultaneous put and call option (e.g. a straddle).

    In any case, my Bloomberg terminal says the option is worth 4bps out to 2015, and we have beat this to death. that means expected inflation is within 5 bps of the breakeven rate, plus or minus liquidity premium which is small.

    last post on the subject. you are totally misinterpreting this paper. like i said, go talk to your finance professor about it.

  112. Gravatar of Major_Freedom Major_Freedom
    25. June 2012 at 06:52

    dwb:

    No, you don’t understand the ABSENCE of put-call parity in JS’ “alternative” pricing models, and you are misreading the paper, and you are misunderstanding my argument.

    You originally, and quite fallaciously, claimed that there is no embedded call option in a TIPS bond, but rather a put option instead. Since you did not believe me, I cited a paper for you that shows yes, there is indeed a call option embedded in the bond.

    Now you’re moving goal posts and making a different claim that the call option somehow does not exist, because it is really just a put option according to put-call parity?

    —–

    If you accept that one can price a TIPS bond as long a vanilla bond and long a call option on a real bond, then I’m done. I showed how a TIPS bond can be priced using a call option.

    You’re clearly now trying to backtrack and change what you said. It makes no sense for you to first deny that there is a call option embedded in a TIPS bond, and then claim that there is an embedded put option according to put-call parity. That alone IMPLIES the validity of the call option component.

    The JS paper only look at ONE “embedded option”. You can interpret that as a call option or a put option, it doesn’t matter for my argument, since my argument is that it has a call option (which you can also say is a put option according to put-call parity), plus a put option that is independent of JS’ entire model.

    In the first case, “if the CPI increases over the life of the bond, at maturity the bondholder will exercise the call option and swap the bond for the upward-adjusted principal of the real bond. On the other hand, in the case of deflation… the call will expire worthless. “.

    Ergo call option.

    In the second case:

    “in case of deflation … the bondholder will exercise the put option and swap the real bond for the unadjusted principal of the nominal bond.”

    Ergo put option according to put-call parity, which is NOT the put option like quality I was referring to above.

    These are two equivalent treatments, but there is not BOTH a simultaneous put and call option (e.g. a straddle).

    In JS’ model, no.

    But in MY treatment, yes, there is. There is gain to be made with in the money deflation, and there is a gain to be made with in the money inflation.

    In any case, my Bloomberg terminal says the option is worth 4bps out to 2015, and we have beat this to death.

    You probably don’t even know what that means.

    that means expected inflation is within 5 bps of the breakeven rate, plus or minus liquidity premium which is small.

    No, you cannot infer that, as I have already shown that to death.

    last post on the subject. you are totally misinterpreting this paper.

    No, you are misinterpreting the paper, and you are changing your story.

    You originally said there was no call option in the bond, but rather a put option. I cited a paper that shows there is a call option embedded in the bond.

    You are also misinterpreting prices in the TIPS market.

    God help the poor souls whose portfolios are in ANY way affected by your judgment. Which firm do you work for so that I never put my money there?

  113. Gravatar of Shane Shane
    25. June 2012 at 07:04

    @ Joel,
    Well, yes and no. In his post on an ideal tax regime–one of the best if you haven’t check it out before (http://www.themoneyillusion.com/?p=7091)–he defines wealth as the present value of all future consumption. As many people do not die with zero wealth, you have to count charity and other bequests as consumption for the numbers to add up. This version of the progressive consumption tax basically works like a Roth IRA–tax all current labor income the same and eliminate capital gains taxes. As a result, it does tax investment/charity derived from current labor income.

    One benefit of this system is simplicity. Or at least it seems simple, until you try to close what you might term the “Mark Zuckerberg” loophole: because he only invested a nominal sum of his own after tax labor income into the company, and because all of those (admittedly diminishing) capital gains would be totally tax free, much of his consumption could be tax free also (he currently lives quite frugally I believe, but then again he currently faces taxation if he sells his assets). Even if we added extra VAT/excise taxes, it is still likely that the consumption of the lucky would be taxed at a much lower rate than a successful doctor. Why double the luck of such individuals? Why not go with PCTs that work more like a traditional IRA–no taxes on investment, until that money is withdrawn for personal consumption. This would eliminate the Zuckerberg loophole.

  114. Gravatar of Major_Freedom Major_Freedom
    25. June 2012 at 07:23

    dwb:

    Since this is important, I will explain why I think there is a put option IN ADDITION to the “embedded option” that is either call or put, as per JS.

    I will assume the “embedded option” as per JS is priced according to using a call option specifically.

    So where is the put option? Suppose there is massive deflation. Suppose this deflation wipes out the counterparties to those going long gold futures as an inflation hedge, who want to take delivery. In this scenario, the principle of the hedge, the physical gold, is not guaranteed. With high deflation, the counter-party may default.

    Now enter TIPS. With TIPS, the principle is guaranteed, no matter how high deflation gets. The government can print its own money. It cannot go insolvent.

    Therefore, an investor can make a gain on both the high inflation and high deflation side. This is similar to a flat straddle, where the synthetic security has two different implied strike prices. With high deflation, the guaranteed principle creates a real gain unavailable with other inflation hedges whose principle is not guaranteed. THAT is what creates the put like feature I was talking about, that is separate from JS.

    And, trivially of course, with high inflation, the variable principle creates a real gain.

    So yes, there is a straddle like payoff structure to a TIPS bond. On the one hand, the guaranteed principle pays off with deflation that other inflation hedges don’t have. On the other hand, the variable principle on the upside pays off with inflation.

    ——

    If you don’t want to accept this additional put feature, then fine, but please don’t make it seem like you have been right all along. Your claim on the non-existence of a call option was contradicted.

  115. Gravatar of dwb dwb
    25. June 2012 at 07:38

    nope, still no. its not a flat straddle. as noted in the paper the call option position is long an unadjusted nominal bond plus a call option, so if you own the call you don’t own TIPS, just a synthetic equivalent.

    if you own the TIPS, you own a position in a fully adjusted real bond, plus a put option.

    check out their 2007 paper as well, where they price breakeven tips including the option price.

  116. Gravatar of Mike Sax Mike Sax
    25. June 2012 at 08:05

    Major I can only conclude you’ve either never been married or if you were it wasn’t long.

    Rebel, what mathemtical methods of Major’s do you disagree with? His taking a huge bunch of aribitrary monthly inflation rates adding them up and dividing and saying this is what counts?

  117. Gravatar of Major_Freedom Major_Freedom
    25. June 2012 at 09:03

    dwb:

    nope, still no. its not a flat straddle.

    In my model, yes it is.

    as noted in the paper the call option position is long an unadjusted nominal bond plus a call option, so if you own the call you don’t own TIPS, just a synthetic equivalent.

    As noted in the paper, a TIPS bond can be priced using a call option.

    As noted by me, a TIPS bond also has a put option like quality that is separate from the put option model in the paper.

    if you own the TIPS, you own a position in a fully adjusted real bond, plus a put option.

    If you own a TIPS, you own a long position in a nominal bond, plus a call option written on a real bond.

    check out their 2007 paper as well, where they price breakeven tips including the option price.

    You mean the paper where they write:

    “Thus, unique to the US, a long position in a zero-coupon TIPS bond is equivalent to a long position in a zero-coupon nominal Treasury bond and a long position in a European call option written on a fully adjusted (real) zero-coupon riskless bond.”

    Yeah, I read that too.

  118. Gravatar of Major_Freedom Major_Freedom
    25. June 2012 at 09:04

    Mike Sax:

    Major I can only conclude you’ve either never been married or if you were it wasn’t long.

    You sound mad.

  119. Gravatar of Major_Freedom Major_Freedom
    25. June 2012 at 09:05

    Mike Sax:

    Rebel, what mathemtical methods of Major’s do you disagree with? His taking a huge bunch of aribitrary monthly inflation rates adding them up and dividing and saying this is what counts?

    The monthly rates are calculated from FRED data. They’re only “arbitrary” to the degree FRED is arbitrary.

  120. Gravatar of Mike Sax Mike Sax
    25. June 2012 at 09:06

    Talk about calling the kettle black Major!

  121. Gravatar of Mike Sax Mike Sax
    25. June 2012 at 09:07

    It’s arbitrary to start when you did and use montly data.

  122. Gravatar of Major_Freedom Major_Freedom
    25. June 2012 at 09:13

    Mike Sax:

    Talk about calling the kettle black Major!

    Which kettle, and why am I a pot?

    It’s arbitrary to start when you did and use montly data.

    Why is it arbitrary to start when I did? Would it have not been arbitrary if I selected the month where inflation was at a local peak, so as to produce an estimate of 1.1%?

  123. Gravatar of Mike Sax Mike Sax
    25. June 2012 at 09:30

    And going by a monthly data is just plain wrong. You’re the pot most widely believed to be crazy. I guess here you agree with Sumner that “There’s no such thing as public opinion”

    Certainly no one thinks it crazy to imgagine you’d drive any woman crazy living with you seeing what a no it all you are and the way you so long windedly and endlessly argue your point. I mean this post has 122 comments and about 112 of them are you.

  124. Gravatar of dwb dwb
    25. June 2012 at 09:37

    As noted by me, a TIPS bond also has a put option like quality that is separate from the put option model in the paper

    lol. i’ll notify bloomberg, fabozzi, cfainstitute, society of actuaries, MF has a new model! lol. OCC/Fed will be VERY interested.

  125. Gravatar of Major_Freedom Major_Freedom
    25. June 2012 at 12:06

    dwb:

    lol. i’ll notify bloomberg, fabozzi, cfainstitute, society of actuaries, MF has a new model! lol. OCC/Fed will be VERY interested.

    You can call them and recommend that they at least read and understand the JS paper I linked to, because it shows TIPS bonds do have an embedded call option, contrary to your initial claim here:

    http://www.themoneyillusion.com/?p=15005#comment-166263

    when you wrote:

    “you are all wrong about TIPS there is no call option”.

    Oops.

  126. Gravatar of Major_Freedom Major_Freedom
    25. June 2012 at 12:08

    Mike Sax:

    And going by a monthly data is just plain wrong.

    Why?

    You’re the pot most widely believed to be crazy. I guess here you agree with Sumner that “There’s no such thing as public opinion”

    Who’s the kettle then?

    Certainly no one thinks it crazy to imgagine you’d drive any woman crazy living with you seeing what a no it all you are and the way you so long windedly and endlessly argue your point. I mean this post has 122 comments and about 112 of them are you.

    Awww, you sound mad. At least I am not posting 112 links to his own blog on someone else’s blog that has more hits.

  127. Gravatar of Major_Freedom Major_Freedom
    25. June 2012 at 12:10

    Mike:

    Really, hearing I’m a “know it all” from the likes of you is just hilarious. Your entire approach to me is “know it all.”

  128. Gravatar of RebelEconomist RebelEconomist
    25. June 2012 at 12:28

    @Mike Sax, yes. I think MF should use a geometric average, but I have not read his comments sufficiently carefully to do them justice, as there are just too many of them.

  129. Gravatar of dwb dwb
    25. June 2012 at 12:47

    “you are all wrong about TIPS there is no call option”.

    still not wrong: if you own TIPS, you own a position in a fully real bond, plus a put option. TIPS are equivalent to an unadjusted nominal bond plus a call option, so if you own the call you don’t actually own TIPS, just a synthetic equivalent. you can say it as many times as you like, you are misreading the literature.

  130. Gravatar of Major_Freedom Major_Freedom
    25. June 2012 at 13:01

    dwb:

    still not wrong: if you own TIPS, you own a position in a fully real bond, plus a put option.

    Still wrong: “you are all wrong about TIPS there is no call option”

    Still right: “A TIPS bond has an embedded call option. This premium may rise, and the yield spread MAY fall, when future inflation expectations rise.”

    TIPS are equivalent to an unadjusted nominal bond plus a call option, so if you own the call you don’t actually own TIPS, just a synthetic equivalent. you can say it as many times as you like, you are misreading the literature.

    I never said one owns an actual call when one buys a TIPS. I have always said “embedded”. Are you just making things up at this point?

  131. Gravatar of Major_Freedom Major_Freedom
    25. June 2012 at 13:04

    RebelEconomist:

    I think MF should use a geometric average, but I have not read his comments sufficiently carefully to do them justice, as there are just too many of them.

    I’ll summarize it down to its bare bones:

    Geometric averages greatly depend on the initial starting value, which can bias the result if the starting value is itself an outlier, such as being at a local peak of historically above mandate inflation (e.g. price inflation at 2008-07-01 was over 5% YoY).

    With monthly averaging, the starting value carries less weight. But of course the trade off is that the interim months carry more weight.

  132. Gravatar of Mike Sax Mike Sax
    25. June 2012 at 13:05

    Major if I sound mad to you also suffer from bad hearing alond with your many other defects Maybe that’s why you repeat yourself so much people with poor hearing often do. I say what I say not from anger but pure mirth.

    People follow my links and like them which is more than can vbe said for your compulsive commenting

  133. Gravatar of Major_Freedom Major_Freedom
    25. June 2012 at 13:21

    Major if I sound mad to you also suffer from bad hearing alond with your many other defects Maybe that’s why you repeat yourself so much people with poor hearing often do. I say what I say not from anger but pure mirth.

    Yeah, you’re right, I can’t hear you. Maybe if you speak a little louder, I might catch what you’re typing on an internet blog.

    People follow my links and like them which is more than can vbe said for your compulsive commenting

    Keep having the faith. Reality is bound to catch up with someday.

  134. Gravatar of Matt Waters Matt Waters
    25. June 2012 at 15:04

    “I am saying if TIPS spreads fall, then you cannot infer from this that “the market” is expecting falling inflation. That’s it. That’s all I am saying. I am saying it COULD mean increasing inflation expectations OR it COULD mean decreasing inflation expectations. It doesn’t necessarily mean falling inflation expectations, because of the embedded call and put options, as well as other factors, complicating the issue.”

    This is absolute nonsense. It’s like saying this:

    “Falling GE stock prices COULD mean lower profits in the future or it COULD mean higher profits in the future. Just because GE’s stock has fallen does not mean that investors think that GE as a company is worth less today, because of embedded put and call options, and other issues.”

    Look, you are horribly confusing the issue with all the talk of embedded put and call option. Here’s the basic fact: the Treasury adjust principal upward for TIPS bonds if CPI goes up. The principal is not adjusted upward for regular treasuries. If the CPI will go up much more in the future, then an arbitrage opportunity exists and the market currently has TIPS bonds mispriced.

    I have no idea where you’re going with all the other nonsense, but the simple fact is that if the TIPS spreads underestimate inflation, then Wall Street is selling a dollar for fifty cents. That’s a mispricing and you are saying the market is wrong, pure and simple.

  135. Gravatar of Major_Freedom Major_Freedom
    25. June 2012 at 16:20

    Matt Waters:

    “Falling GE stock prices COULD mean lower profits in the future or it COULD mean higher profits in the future.

    Actually that is correct! Haha.

    There are other factors besides profitability that will affect stock prices, for instance change in dividend payout ratio vis a vis liquidity preference, capital structure reorganization, etc.

    Just because GE’s stock has fallen does not mean that investors think that GE as a company is worth less today, because of embedded put and call options, and other issues.

    Worth is different from profits. You just equivocated the two.

    Look, you are horribly confusing the issue with all the talk of embedded put and call option.

    Not really. I am just talking about what it is. If it is confusing, sorry.

    Here’s the basic fact: the Treasury adjust principal upward for TIPS bonds if CPI goes up. The principal is not adjusted upward for regular treasuries. If the CPI will go up much more in the future, then an arbitrage opportunity exists and the market currently has TIPS bonds mispriced.

    False. I am not arguing for two market or equivalent security mismatching of prices. There is no arbitrage implied here.

    I have no idea where you’re going with all the other nonsense, but the simple fact is that if the TIPS spreads underestimate inflation, then Wall Street is selling a dollar for fifty cents.

    I am not saying TIPS spreads communicate inflation, so how can I say it’s mispriced?

    That’s a mispricing and you are saying the market is wrong, pure and simple.

    Nope. You’re wrong. You;re horribly confused.

  136. Gravatar of Joe Joe
    25. June 2012 at 16:42

    Where is a Morgan Post when you need some reality???

  137. Gravatar of ssumner ssumner
    25. June 2012 at 18:12

    Shane, You said:

    “As for your claim that, “Wealth is the present value of future consumption”–this is, as you note, only true if we consider charity and bequests as consumption. But that seems like a highly odd definition. If you have no objections to taxing consumption first as wages and then through a VAT, what then is wrong with double taxing this type of consumption first as wages and later as a gift/inheritance tax? Or triple taxing it by throwing in capital gains?”

    I’m not sure you understand the problem with taxes on capital, they tax future consumption at a higher rate than current consumption. That doesn’t happen with a payroll tax added to a VAT.

    As for charity, why in the world would you want to tax the part of wealth that goes toward charity?

    Daniel, I’m not a fan of Chomsky, but I agree that we are the bad guys on occasion—as for instance pressing a drug war on Latin America. I have not followed the Assange case closely. In generally I favor the exposing of state secrets, unless they are details about nuclear weapons, or troop movements, etc. If it’s just embarrassing stuff the US is doing with shady people, I want that exposed.

    Rebeleconomist, I think you are wrong. The Fed has reduced inflation sharply in recent years, whether you use the old technique or the new one. I can’t believe that’s what Bernanke wanted. I am using the same data the Fed uses, and they aren’t hitting their own target.

    John Becker, I answered your question in a different post.

  138. Gravatar of Shane Shane
    25. June 2012 at 21:22

    Dr. Sumner,

    No, no, I understand that. My point was that it is absurd, that we shouldn’t think of investment or charity as consumption at all, and hence it would be better to adopt a tax that works more like a traditional IRA, excluding investment/charity up front.

    As more economists left and right begin to support consumption taxes, it will be interesting to see the debate increasingly shift to how to implement it. Those differences are glossed over right now for the sake of the greater cause.

  139. Gravatar of RebelEconomist RebelEconomist
    26. June 2012 at 00:40

    @MF, The order of the numbers is irrelevant in calculating an average. If you are worried about outliers, you could use the median instead – the median of the monthly price changes given by dwb on 24 June 2012 at 10:10 is 2.0% annualised, which perhaps lends support to your argument.

    If you find yourself writing many long comments on a particular issue, MF, then I recommend that you set up your own blog, write a carefully considered blog post and refer people to it. You will not get any criticism from me for linking to your own blog from a more popular blog, because that is what I have done myself. You can also track the readers on your own blog, and thereby judge whether your ideas are appreciated. As it is, with your large number of long and hasty comments on this blog, you are overwhelming what could be a readable, incisive discussion here, which would in my view force Scott Sumner to acknowledge and find answers to the weaknesses in his own ideas.

  140. Gravatar of Saturos Saturos
    26. June 2012 at 03:33

    “I think MF should use a geometric average, but I have not read his comments sufficiently carefully to do them justice, as there are just too many of them.”

    You don’t need to read through thousands of words to check the intellectual soundness of an argument, when its proponent commits howlers like this:

    “Geometric averages greatly depend on the initial starting value”

    MF is unfamiliar with the commutativity property of multiplication. That’s it. You fail life.

  141. Gravatar of Saturos Saturos
    26. June 2012 at 03:35

    Yes MF, why don’t you just link to your own blog like Mike Sax does, instead of taking up so much space on Scott’s blog (which is really a public monument) with comments that mostly no one else wants to read (safe bet)? You could call it, “The BatCave”. Or, “Major Freedom’s Boot Camp”.

  142. Gravatar of Major_Freedom Major_Freedom
    26. June 2012 at 04:50

    Saturos:

    You don’t need to read through thousands of words to check the intellectual soundness of an argument, when its proponent commits howlers like this:

    “Geometric averages greatly depend on the initial starting value”

    MF is unfamiliar with the commutativity property of multiplication. That’s it. You fail life.

    You fail at reading comprehension.

    It’s not about communativity. Yes of course you can multiply the factors in any order you want, but if you were paying attention, the method that was being used was this:

    {[CPI(today) / CPI(2008-07-01)]^(1/46)}^12

    This is mathematically equivalent to calculating a particular annual average that itself becomes all the x’s in the geometric mean: 46th_root(x1 * x2 * x3 * x4…* x46).

    If all these x’s are equal, then yes, of course it doesn’t depend on the initial value, since they’re all the same!

    But because the average inflation estimate is calculated AS IF that particular average inflation estimate is what is needed to produce the final CPI value GIVEN that we use a geometric series, then the “initial value” I was referring to is NOT the x’s, i.e. the average inflation estimate, but rather the initial CPI (2008-07-01) value.

    The reason why there is a debate here between arithmetic and geometric means, has to do with whether or not we should select the average inflation estimate that is needed to reconcile the CPIs in terms of geometric method, or select the average inflation estimate that is month to month arithmetic mean, which does not depend so much on the initial CPI value.

    Get a grip dude. Instead of taking your inability to grasp the debate, and then believing that it means I am wrong, please at least try to make it seem like you know what is being talked about.

    Yes MF, why don’t you just link to your own blog like Mike Sax does, instead of taking up so much space on Scott’s blog (which is really a public monument) with comments that mostly no one else wants to read (safe bet)? You could call it, “The BatCave”. Or, “Major Freedom’s Boot Camp”.

    It wouldn’t annoy you as much, haha

  143. Gravatar of Major_Freedom Major_Freedom
    26. June 2012 at 05:00

    RebelEconomist:

    @MF, The order of the numbers is irrelevant in calculating an average. If you are worried about outliers, you could use the median instead – the median of the monthly price changes given by dwb on 24 June 2012 at 10:10 is 2.0% annualised, which perhaps lends support to your argument.

    The order of monthly or annual INFLATION ESTIMATE numbers is irrelevant, yes. But that’s not the initial value I was referring to. I was referring to the initial CPI value, which is used to the calculate the inflation average.

    The monthly average via geometric mean is 46th_root of(x1 * x2 * … * x46). If we go the reverse, and try to estimate what those x’s are, then we go x = [CPI(current month) / CPI(2008-07-01)]^(1/46).

    This gives us a SINGLE “x” value that is being inferred from 46th_root(x1 * x2 * … * x46).

    My argument is that the monthly inflation estimate using the geometric method depends too much on the initial, CPI(2008-07-01) value. The entire series of x’s rests on this initial value.

    If you find yourself writing many long comments on a particular issue, MF, then I recommend that you set up your own blog, write a carefully considered blog post and refer people to it. You will not get any criticism from me for linking to your own blog from a more popular blog, because that is what I have done myself.

    I don’t do that.

    You can also track the readers on your own blog, and thereby judge whether your ideas are appreciated.

    Not really my concern.

    As it is, with your large number of long and hasty comments on this blog, you are overwhelming what could be a readable, incisive discussion here, which would in my view force Scott Sumner to acknowledge and find answers to the weaknesses in his own ideas.

    He can do that through my comments.

    I don’t think your recommendation is something I am interested in.

    There are many others here who post many comments, but they aren’t getting the treatment I am getting, because their arguments are safe and in line with the consensus. You don’t need me to add to the borg. There’s enough of you.

  144. Gravatar of Major_Freedom Major_Freedom
    26. June 2012 at 05:27

    I am using the same data the Fed uses, and they aren’t hitting their own target.

    Not hitting their target….going back how far? Short term or long term? What is short term? What is long term?

    If you choose an initial starting value that just so happens to be a local maximum which is far above the Fed’s 2% target (2008-07-01 inflation was over 5%, the month you’re selecting as the starting value), then should inflation come back down thereafter, then of course you’ll calculate an inflation estimate that is lower, or even below target.

    But if you look at the long term, which is the Fed’s actual time horizon mandate (not short term 46 month periods of micromanaging the economy), then inflation has been (geometric estimate):

    2.17% since Jan 2007

    2.16% since Jan 2006

    2.40% since Jan 2005

    2.45% since Jan 2000

    2.64% since Jan 1990

    3.37% since Jan 1980

    4.33% since Jan 1970

    3.99% since Jan 1960

    3.71% since Jan 1950

    ——-

    Why can’t we argue that the Fed should run below 2% price inflation for many years, at least until the long term averages come back down to their target of 2-3%?

    Just like you say the Fed should inflate to “catch up” assuming the mandate were NGDPLT, then given the Fed’s actual current mandate of 2-3% price inflation, shouldn’t they “catch up in reverse” for overshooting their target all those years?

    Yes, this means you won’t get more NGDP, but shouldn’t the Fed continue to practice their actual mandate of price inflation targeting, until it is officially changed? Or should the Fed just do whatever they want, regardless of the mandate they have been “democratically” tasked to do?

    Why do you keep insisting that the initial starting data to measure CPI inflation just so happens to be the month where price inflation was at a local max of over 5%? What is so special about “the last 46 months” other than the rather obvious intention to bias the resulting price inflation estimate lower so as to be a talking point that reinforces the desire for more toilet paper printing?

  145. Gravatar of Matt Waters Matt Waters
    26. June 2012 at 07:37

    “False. I am not arguing for two market or equivalent security mismatching of prices. There is no arbitrage implied here.”

    Yes, for the last time, there is.

    Let’s say you’re Biff in Back to the Future 2 and your future self gives you a book of economic statistics from 2022. You see that the CPI averages 5% because of all Bernanke’s silly money-printing.

    If you short $10,000 of Treasuries and then take that $10,000 and buy TIPS bonds with 1% inflation premium, then you are GUARANTEED cash flows while putting up no money. You will have to put up margin, but the margin itself will earn the risk-free rate.

    In reality, you don’t have a 2022 book of economic statistics and so you aren’t guaranteed the cash flow on zero capital. But you seem very damn sure that inflation will be somewhat higher than TIPS spreads indicate. If you are so sure about that, then why wouldn’t you get free cash flow on zero principal from the arbitrage trade?

  146. Gravatar of Major_Freedom Major_Freedom
    26. June 2012 at 11:35

    The blog is hungry. It is eating comments. They’re there, then they’re not.

  147. Gravatar of Major_Freedom Major_Freedom
    26. June 2012 at 11:38

    Matt:

    There is no arbitrage opportunities between today’s prices, and tomorrow’s uncertain prices.

    You’re asking me to suppose I see my own self from the future, telling me what’s going to happen. Yes, if that were possible, then the world would revolutionize in ways beyond my current ability, and yes, you might see inter-temporal arbitrage.

    But we don’t live in that world, so your analogy is moot.

  148. Gravatar of Saturos Saturos
    27. June 2012 at 01:24

    Scott, what do you say to liberals who accuse you of defending “trickle-down” economics?

  149. Gravatar of Saturos Saturos
    27. June 2012 at 01:27

    MF, that’s it. Please stop talking. Intertemporal arbitrage is the foundation of capitalism, and if you know absolutely zero about economics as to realize this, then you can just go boil your head.

  150. Gravatar of Major_Freedom Major_Freedom
    27. June 2012 at 03:53

    Saturos:

    Your ignorance goes even deeper than I first imagined. “Intertemporal arbitrage” is a veritable impossibility. It is not the foundation of capitalism. The foundation of capitalism is intertemporal action that contains uncertain payoffs, which may include statistical “arbitrage.” These aren’t guaranteed profits however. They are not deterministic.

    If you had bothered to learn what arbitrage consists of, you would have known that arbitrage is not even intertemporal. It is “current.” Arbitraging is exploiting two or more PRICES, which only ever exist in the present.

    Please stop talking? How about you start reading.

  151. Gravatar of ssumner ssumner
    27. June 2012 at 09:30

    Shane, I agree that implementation issues can be tricky, which is why I support both a VAT and a payroll tax–it minimizes the damage done by an error in implementation. It also reduces tax evasion.

    Saturos, You said;

    “Scott, what do you say to liberals who accuse you of defending “trickle-down” economics?”

    How’s that possible, if I think the tax system should be progressive, as Matt Ygleisas also believes?

  152. Gravatar of Saturos Saturos
    27. June 2012 at 19:09

    MF, I can buy a house and sell it later at a higher price, which exists at a different time. And it’s certain that house prices will go up over time, as Australia’s population is increasing faster than the government is releasing land for development. If the current price were less than the discounted future price, which has a certain lower bound given basic supply and demand, then people would buy until the price rose to intertemporal equilibrium. But (the lower bound on) the future price is no more uncertain than the fact that the sun will shine tomorrow. Well, not much more uncertain, anyway.

    Scott, I’m referring to lowest common denominator liberals, the ones who don’t see why you shouldn’t tax capital, or for that matter why we shouldn’t have 70% MTRs on the rich. The ones who have no understanding of the concept of gains from trade. (Like Stephen Colbert satirically suggested to Thom Yorke a few months ago, “You have to give the corporations more money, and then it will trickle down to the rest of us, you see.”) Come on, you must have met some.

  153. Gravatar of Major_Freedom Major_Freedom
    30. June 2012 at 19:44

    Saturos:

    MF, I can buy a house and sell it later at a higher price, which exists at a different time.

    You don’t know the future price, in the present. It is a risk to buy a house with the intention of reselling it.

    Arbitrage is a risk free profit.

    And it’s certain that house prices will go up over time, as Australia’s population is increasing faster than the government is releasing land for development.

    That is false. It is NOT certain that house prices will go up over time.

    If the current price were less than the discounted future price, which has a certain lower bound given basic supply and demand, then people would buy until the price rose to intertemporal equilibrium.

    Equilibrium is never reached.

    But (the lower bound on) the future price is no more uncertain than the fact that the sun will shine tomorrow. Well, not much more uncertain, anyway.

    It is uncertain.

  154. Gravatar of That Old Tree Called Liberty » Blog Archive » Governing By the Majority That Old Tree Called Liberty » Blog Archive » Governing By the Majority
    12. July 2012 at 18:24

    [...] question almost guarantees a specific outcome. This is occurring all across the nation.   TheMoneyIllusion » There is no such thing as “public opinion” (examples #233 and #234) [...]

  155. Gravatar of TheMoneyIllusion » The public opposes Obama’s call for higher tax rates on the rich TheMoneyIllusion » The public opposes Obama’s call for higher tax rates on the rich
    15. November 2012 at 07:51

    [...] readers of this blog know, I have consistently argued that there is no such thing as public opinion.  But other bloggers keep citing public opinion, as [...]

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