Government reports of inflation are derision magnets. The freshly released inflation figure is easily the least popular kid in the economic class of statistics and can usually be found seeking solace next to his old punching bag buddy the quarterly GDP estimate.
Why are inflation numbers so unpopular? My own opinion is that the anger and debate this statistic engenders is due to the fact that it can’t possibly handle the work load assigned to it. Everyone wants inflation to tell a story about their current view on the economy and the future, yet it can’t do that.
The whole problem with inflation is that it is a point metric describing a complex system. What? Yes you heard me, it is a point metric, a single point trying to describe the state of a complex system.
One Average I feel fine.
Inflation is limited as an economic barometer in that it is
an average. There is old introduction to
statistics about a man with his feet in a block of ice and his head an
oven, the old fellow replies that, “Oh, on average I feel fine.” Inflation currently reports the
How it really works and why we should be nervous.
The system illustrated isn’t fine, eventually the output is going to be in for a wild ride. One could suggest that variance in the system components may say more about future GDP change than inflation alone.
Most people assume the inflation number represents a flow metric driving another flow metric, namely future GDP growth (economic output). One could argue that inflation metrics are better used when combined with component variance as an indicator of future likely GDP variance. Most likely variance is tied to inefficiency and thus temporary GDP contraction.
Central bankers, economists and other dangerous folk try stabilizing inflation using basic monetary tools. The assumption being that stable inflation is correlated with higher stable GDP growth. The reason I call these people dangerous is that they are attempting to control something mostly outside of their control with blunt tools. Most central bankers are oracles with only half the required amounts of entrails required for predicting the future ;). What should one advocate as proper policy for the system illustrated above?
I believe central bankers to be well meaning people, but my hunch is that outside of regulatory oversight roles, the least active central bankers are probably the most effective ones. Many interventions meant to stabilize the system may actually increase uncertainty and variance in the system, thus lowering long term GDP growth.
The safest thing a central banker can say is, “I don’t know what is really going on right now, but I am going on holiday until it sorts itself out.” The economic system eventually stabilizes itself. This is the laissez faire economics schtick after all. Unfortunately oracles who claim not to possess the gift of fortune telling typically get replaced, so we are all a bit to blame as well. Please put down those monetary control tools, you may hurt someone.
Pattern recognition is psychologically wired into all of us. Biology makes us prone to many errors of judgemen and beliefs in contol that flawed.
The working thesis is that low 1-2% stable inflation is correlated with growing GDP. The things that create stable GDP and stable inflation are probably regulatory certainty and monetary stability. Perhaps the politicians should go on holiday with the central bankers and let the rest of us get on with it.
No more stimulus checks please, its beginning to economically
The typical assumptions of dampening the economic cycle via active monetary policy is nice, but may be flawed due to the multiple feedback loops in the economy. See or better yet play the beer game to understand how this works.
So the next time you see a central banker or politician, encourage them to take it easy and perhaps find a bit of sun somewhere far away.
If anyone has some pointers or research on economic component variance as a future GDP indicator or monetary policy inactivity as it relates to GDP growth please post a link in the comments. I enjoy listening and learning.