Friday, January 7, 2011

21st Century Inflation

The reigning methodology [for collecting inflation data] is, well, clunky. It costs Washington around $234 million a year to get all those people to go and bear witness to a $1.57 price increase in a packet of tube socks and then to massage those individual data points down to one number. Moreover, there is a weekslong lag between the checkers tallying up the numbers and the government announcing the changes: The inflation measure comes out only 12 times a year, though prices change, sometimes dramatically, all the time. Plus, the methodology is archaic, given that we live in the Internet age. Prices are easily available online and a lot of shopping happens on the Web rather than in stores.
Answer #1 - the Billion Prices Project from MIT - "based on 5 million items sold by 300 online retailers in 70 countries. (For the United States, the BPP collects about 500,000 prices.)"

Answer #2 - Google it - using every price available on Google showed periods of deflation that the CPI did not.

Both new measures track the CPI well, confirming that the old clunky method still does useful things. But if the other methods are available at less expense, greater ease, more frequently, and so forth, maybe there is time to consider a transition?

In other inflation discussion, Beckworth notes that, yes, of course velocity and money supply move infversely: that's one of the things the Fed is supposed to do to keep inflation low! When velocity changes, the Fed responds by purchasing or selling bonds and changing the amount of money in the economy. And overall it has done quite well during the 30 years between Volcker and the current recession. During the 60s and 70s... not so much [see figure]. And during each recession since Volcker, the correlation breaks down.

In a comment, Rowe reminds us of Friedman's thermostat analogy:

"If a house has a good thermostat, we should see no correlation between the inside temperature (NGDP) and the amount of oil burned in the furnace (M).

We should also see no correlation between the inside temperature (NGDP) and the outside temperature (V).

And we should see a strong correlation between the outside temperature (V) and the amount of oil burned (M)."

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