Charts that Count: how to go inflation shopping
Stephen Moore, Donald Trump's new nominee for a seat on the US Federal Reserve's Board of Governors, has proposed that the Fed follow commodity prices as a measure of inflation. There are a lot of ways to measure inflation. Sometimes people who want to nudge the Fed in a certain direction go 'inflation shopping'. They pick the inflation measure that gives them the result they need. Brendan Greeley, US editor for FT Alphaville, explains.
Produced by Gregory Bobillot. Filmed and edited by Donell Newkirk.
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So Stephen Moore, that's Donald Trump's new nominee for the Federal Reserve Board of Governors, has suggested in an op-ed that the Fed should target commodity prices when it's looking at inflation. Here's what the Fed targets right now.
This is price changes in core personal consumption expenditures. Personal consumption expenditures, this is just a basket of all the things that you buy - cell phone service, cars - they're weighted depending on how much money you spend. And then you throw out some stuff that's really volatile: energy prices and food prices, right?
Those bounce all around. You want an accurate measure, so you're just looking at core prices that people spend every month. That's what the Fed is tracking.
Here's what Stephen Moore wants to track. He wants to track the price of commodities. This is mostly gas and oil, energy products, but also metals - steel, aluminium. The measure we're using here, there are lots of different ways to measure it, but this is the producer price index. This is what companies pay for commodities.
OK, why would you want to do that? There are a ton of different ways to measure inflation. I'm not going to go into detail on all these.
There are consumer surveys, like the Michigan survey, that asks consumers what they think inflation is going to be. There are market measures, like the five -year, five -year forward. It looks at a complex measure of Treasury prices, see what people think inflation is going to be in the future.
There is this measure, Trimmed Mean PCE from the Dallas Fed. And then there's the Median CPI from the Cleveland Fed. They're fascinating. We'll talk about them some other time. But there are different ways to look at inflation.
And the question is always, if you're arguing for a certain kind of inflation, are you genuinely interested in the best way to measure price change? Or are you... or are you inflation shopping? Basically, if you can argue that inflation is really low, you can get the Fed to be more aggressive, and accommodative, and help the economy grow more. If you can argue that inflation is high, then you can get the Fed to back off.
And at various times over the last 10 years, you've heard different people argue for different measures. So Stephen Moore, new nominee to the governor's board, is he arguing or is he inflation shopping? OK, so let's look at what commodity prices do.
In the early 80s, there was some discussion about actually tracking commodity prices for the Fed. The problem is they were already pretty volatile back then. They move around a lot. They're fantastically volatile now. What's going on?
Political risk. Saudi Arabia makes decisions. Russia makes decisions. Venezuela makes decisions. The United States makes decisions about Iran. There are a lot of things going on in the price of oil that have nothing to do with markets or inflation, and everything to do with politics. The Fed can't control those things, so it's hard to react to those things.
OK, the other problem with tracking commodities is that it seems like it's a diversified basket. You've got metals. You've got agricultural products. You've got energy.
But mostly, it's energy. It's overrepresented. First of all, it's just a big part of what we spend our commodity money on. The other thing is, other commodity prices actually reflect the price of energy.
When you're looking at aluminium, for example, it takes a ton of energy to make aluminium, right? So the price of energy is going to necessarily affect the price of aluminium. It's overrepresented in the entire basket. So if you want to track commodities, what you are really tracking is gas.
The other thing that's happening right now, particularly energy, is subject to what we'd call a secular shift. This is a change in technology that has nothing to do with the underlying market. So right now, fracking technology has changed the way we extract natural gas and oil.
That means when you get periods like this, 2014, 2015, Saudi Arabia, American frackers are competing to drive the price of oil down. That's not really part of the overall inflation picture. That's volatility in technology that has absolutely nothing to do with the rest of the picture of inflation.
So Francisco Blanch, he's a commodities analyst for Bank of America Merrill Lynch, told me that another problem with this measure is that not only is energy becoming more volatile, it's a smaller and smaller part of the basket of what we buy. People are becoming more energy efficient. That's only going to increase in the future.
So you have a measure that is subject to political risk. It's mostly gasoline. It's got these secular shifts going on with technology. It is a smaller and more volatile part of the things that we buy. And this is what Stephen Moore wants to measure.
Now, the Fed does look at commodities, and in particular energy prices, when it's thinking about inflation more broadly. It's one small part of what they're considering. They've said that in their public statements.
But this gives us a clue to what Stephen Moore might be thinking. I don't have a channel into his brain. Energy prices in particular are dragging down this broader commodities basket to what you could technically call deflation. Prices are actually decreasing.
What normally happens when central banks see deflation is that they freak out. They're very accommodating. They'll do anything they can to help the economy grow.
So given that energy prices, or commodity prices, are volatile and growing even more volatile, given the fact that it is a small part of the basket, getting even smaller of what we buy, given the fact that it's subject to political risk, given the fact that it's mostly gasoline, given the fact that there are technological shifts, we have to decide. Is Stephen Moore interested in the best way to measure inflation? Or is he inflation shopping?