Senator Rand Paul re-introduces 'Audit the Fed' bil

Reuters  article "Senator Rand Paul re-introduces 'Audit the Fed' bill" (January 28th, 2015) discusses a new bill introduced by Rand Paul, Ted Cruz, and 28 other Senators to "audit the Fed." This would expand the yearly audits taken by 1) Government Accountability Office, 2) the Office of the Inspector General, and 3) Private firms, to include monetary policy discussions, minutes of which are currently released with a three week lag.  Detailed accounts of their holdings are released each week.

The real intent of the bill seems to be to monitor Federal Reserve policy discussion in real time.  This will have two effects: first, to generate more comments for politicians like Rand to jawbone Fed officials about.  Second, it will chill discussion in times of crisis.

In the end, chipping away at the Fed's independence is a good way to get higher inflation.  From Alesina and Summers (1993), the relationship between Federal Reserve bank independence and inflation (click to enlarge).

 

Another aspect of the conservative echo chamber that has lead to insanity.  Sadly, Corrections sees little way to end it.

Edit:  Even a broken clock is right twice a day.  Senator Warren:

[...] but I oppose the current version of this bill because it promotes congressional meddling in the Fed's monetary policy decisions, which risks politicizing those decisions and may have dangerous implications for financial stability and the health of the global economy.

The worst thing for a party about giving up its sanity for poorly-thought-out crusades,is it cedes sanity to the opposition.

Inflation Expectations over Time by Duration

Below, Corrections depicts two different of the 10-year expected inflation rate (that is, the average yearly rate of inflation over the next ten years).  The first comes from the Cleveland Fed, and the second comes from the TIPS break-even rate.

First, we depict three different Cleveland Fed inflation expectations series (click to enlarge):  for the most part, from the 1980's onwards it took time for people's inflation expectations to fall from the highs of the 1970's and they currently range around 1 to 2 percent.

Below, we look at the break-even rate for 10-year TIPS vs. 10-year government bonds (click to enlarge).  Note that TIPS fell dramatically against bonds during Fall 2008, perhaps because of their relative illiquidity during a time when liquidity was highly valued (and are therefore probably not useful as a measure of expected inflation during that period).

 Finally, we look at the two measures together (click to enlarge):  they both suggest that over the next ten years, the yearly inflation rate ranges between 1.5 and 2.5%.

Inflation, Stock Market, and Bond Market Returns

Below, Corrections depicts value-weighted one-year stock market returns (including distributions), one-year Treasury bond returns, and the one-year inflation rate (click to enlarge).  We display each one year lagged return by month, from 1951-2012 (inclusive).

Obviously, unexpected inflation takes away from an already-issued bond's return while having an unclear impact on already-owned stock returns.  Interestingly, simple regression on non-overlapping periods suggests a:

• 3.46% return on one-year bonds with 0.57% increase above and beyond that baseline for each one percent of inflation experienced that year.  
• 15.28% return on stocks with a -.76% loss for each one percent of inflation experienced that year

This may be seen in light of:

• One-year bond's arithmetic (geometric) average return of 5.57% (5.49%) with a standard deviation of 3.76%
• Value-weighted stock market's arithmetic (geometric) average return of 12.49% (11.13%) ( (including distributions) with a standard deviation of 16.36%
• The CPI's arithmetic (geometric) average level of 3.67% (3.68%) with a standard deviation of 3.00%

It is interesting and surprising that while bonds return less than stocks (on average) they return more in periods of higher inflation.  This is counter to the fact that a one log-point fall in unexpected inflation impacts the log return of already purchased bonds by one log-point.

Expected Inflation and Treasury Bond Yields

Below, we plot the Treasury bond yields against the Cleveland Fed's estimates of expected inflation (click to enlarge).  It is important to note that the Cleveland Fed's estimates may be a noisy measure of "true" expected inflation.

A simple model in finance would suggest a one-to-one correlation between expected inflation and interest rates.  More complex models may deviate from this.  For example, they may allow for pricing of uncertainty about inflation (and therefore an inflation risk premium) that correlates with the level of inflation.

TIPS Yield Spreads

Below, Corrections depicts different Treasury-TIPS yield spreads.  The plots take the yield of a regular treasury security of maturity X and subtracting the yield of an inflation-indexed treasury security of maturity X (click to enlarge).

The plot shows not only a remarkable consistency in inflation expectations but the dramatic flight to liquidity during the 2008 crisis.

Consumer Price Index Components and Transportation Breakout

Below, Corrections displays the components of the urban CPI (click to enlarge).  Weighted by expenditure, they make up the headline CPI.

Transportation looks interesting enough to break out further.  Below, we display the components of the transportation component (click to enlarge):

U.S. Monthly Inflation - Annualized

U.S. monthly inflation -  annualized (click to enlarge).

U.S. Debt Structure

From the database associated with Hamilton and Wu (Forthcoming) ""The Effectiveness of Alternative Monetary Policy Tools in a Zero Lower Bound Environment," (data) (paper).  The maturity structure of U.S. Debt.  "Strands" that disappear in the middle indicate debt structure altered by open market operations.  Strands that cease "starting" indicates that bond maturity is no longer issued (for example, the 5 year bond was retired for some time in the 90's).  The first figure is thirty years of maturities (click to enlarge).

This second year looks only at the distribution of U.S. bonds with maturities of five years or sooner (click to enlarge).

Israeli Hyperinflation

Israel's 1983 hyperinflation, from Sargent and Zeira (2011): Israel 1983: A bout of unpleasant monetarist arithmetic (click to enlarge).

Four Hyperinflations

From Sargent's "The Ends of Four Big Inflations" (1982), Corrections presents the hyperinflationary episodes of Germany, Poland, Hungary, and Austria (click to enlarge).  All price indices were normalized to one in the beginning period.  More easily readable in the enlarged version, the vertical scales of each graph, clockwise from top left, are: 10^4, 10^13, 10^5 and , 10^4.

Remarkable.  

Inflation, Money Growth, and GDP Growth

From McCandless and Weber's "Some Monetary Facts" (Federal Reserve Bank of Minneapolis Quarterly Review, 1995), as brought to popular attention by Robert Lucas's 1995 Nobel Prize Lecture, Corrections displays the relationship between money growth, inflation, and real GDP growth.  

The figures display 30-year differences across 110 countries between 1960 and 1990.  

Money growth and inflation have a nearly one-to-one relationship (click to enlarge).

 Money growth and real GDP growth have a nearly zero-correlation relationship (click to enlarge).

Rule of thumb #1: In the long run, inflation is always and everywhere a monetary phenomenon.  

Rule of thumb #2: Money is neutral in the long run.  

Most Recent CPI Variance is Due to Gasoline

From William T. Gavin's "CPI Inflation: Running on Motor Fuel" in the St. Louis Fed's Economic Synopses (May 11th, 2011).  Gasoline dominates headline inflation (click to enlarge).

Taylor Rule and Federal Funds Rate

One simple version of the Taylor Rule and the Federal Funds Rate (click to enlarge).  

Inflation and Prerecession Trends

Here, Corrections displays the Consumer Price Index and a linear projection of the CPI using prerecession data.  It gives an idea of how the recession impacted inflation so far.  It is further worth noting that the CPI is well-known to overstate inflation (causing social security benefits to outpace real inflation) for several reasons, such as an inability to price quality improvements (it should be clear that the quality of most products has risen over time).  It's also worth noting that older measures (such as those used by shadow statistics) overstate inflation even more by not adapting their measure to new products or changing expenditure patterns.

See the consumer price index and projected consumer price index displayed graphically below (click to enlarge).

Debt, Primary Surplus, and Inflation

Four graphs relevant to understanding the current budget situation and inflation.

Historical, real U.S. Debt (click to enlarge).

Historical real U.S. Debt as a Fraction of GDP (click to enlarge).

Historical U.S. primary surplus as a fraction of GDP (click to enlarge).

Historical U.S. inflation rate between quarters, by percent change in CPI (click to enlarge).

Old age robs criminals' skill

Boston Herald article "Old age robs criminals' skill" (September 18th, 2010) offers a rarity for opinion editorials: an intellectually stimulating article and relatively original idea. The article's interesting question is: why does crime rise in some recessions, and fall in others? The article's proposed answer is recessions with high inflation drive crime because criminals see individuals as holding large amounts of cash now in anticipation for needing it in the future (implicitly, an economic "cash-in-advance" model). Recessions with low inflation will simply find individuals with less in their pockets, and therefore less to steal.

But in previous recessions, in the 1970s and ’80s, the crime rates went up. The difference perhaps was that those recessions were in times of high inflation, giving robbers an incentive to take your money while it still held its value.

Being broke, people don’t go out late and thus are less likely to be mugged. And if folks do travel, the thieves know they’re probably not carrying much of value.

If newspaper writers are going to undertake causal analysis or conjecture, it's enjoyable when they use good structure or thoughtful analysis. If the reflexive premises of the New York Times are that firms are evil and people are very dumb and easily tricked, this article argues that even criminals respond to incentives, and puts forth their testable conjecture--the pinnacle of a non-empirical opinion editorial.

As Corrections sees it, the testable prediction the Herald's conjecture offers is as follows: real goods, such as automobiles or jewelry, are relatively robust to inflation. Cash is not. If burglary and robbery are substitutes for one another, but inflation causes robbery to become relatively less valuable than burglary, then a difference-in-difference will bring out the causal link between inflation and crime.

That is to say when inflation changes from low to high, we should expect the difference between the change in robbery and the change in burglary to be negative. Below, we first graphically display the data: inflation rate, robbery and burglary rates over time (click to enlarge), from 1960-2003.

A graphical and first-approximation is to plot percent change in inflation on the x-axis and the difference between percent changes in robbery and burglary on the y-axis. As we can see from the positive slope, if anything an increase in inflation appears to lead to a relative increase in robberies, not burglaries, as the Herald's theory might predict (click to enlarge).

Of course, this is only a first-pass approach. Consumers, recognizing that inflation will cause more robberies, could reinforce their homes and cause less total robberies (due to security) that has a larger effect than inflation causing more robberies. However, the empirical evidence behind the Herald's theory appears weak--rather than burgling more inflation-robust assets when inflation increases, individuals are robbing more inflation-insecure assets when inflation increases.

Recession Raises Poverty Rate to a 15-Year High

New York Times article "Recession Raises Poverty Rate to a 15-Year High" (September 16th, 2010) fails to acknowledge the poverty rate's intertemporally unstable nature. It compares poverty rates over time, an improper comparison due to the way poverty rates are calculated.

The share of residents in poverty climbed to 14.3 percent in 2009, the highest level recorded since 1994. The rise was steepest for children, with one in five affected, the bureau said.

One might think that individuals in the U.S. were only as well off as they were in 2004, when chained GDP/capita was approximately the same as it is this quarter. However, Corrections contends that we are actually even better than this. Below, find graphically depicted U.S. GDP over time in chained 2005 dollars (click to enlarge), and U.S. GDP per capita over time in chained 2005 dollars (click to enlarge). Note that chaining dollars is an attempt to introduce new products for comparison (otherwise, comparing cell phone prices from 1960 and today would not be well-defined).

The poverty rate from 1994 is measuring something completely different from the poverty rate in 2009. Poverty thresholds have changed multiple times, under a "sliding scale" approach. For example, in 1964, ~2.6% of U.S. households owned a color television. Circa 1994, 97% of U.S. households owned a color television. Beyond this, these televisions were not only cheaper, but were of better quality, programming, and durability.

Why is this relevant? Because increasing product quality is not properly measured, even with chained GDP. Below, we take minivans as an example.

In 2003, using Barry, Levinson and Pakes's instrumental method for demand estimation (also discussed in a previous post), Amil Petrin, in his phenomenal paper, "Quantifying the Benefits of New Products: The Case of the Minivan" (JPE 2002) estimates the value in dollars to consumers from the advent of the minivan by Chrysler in its first five years (1984-1988) as $2.8 billion in consumer surplus, and $2.9 billion in total surplus.

This surplus comes solely from an improvement in product quality that is largely unreflected in price due to monopolistic competition by competitors (GM and Ford introduced their own minivans in 1985). This sort of change will not be reflected by even chained GDP numbers. Because of increasing product differentiation (Petrin's "new goods" problem) and monopolistic competition (or competition), life is getting better than we're measuring with our best measures of product-chained GDP. Quality of life is higher.

Poverty indicators are not appropriate for "long" time spans because of innovation. Locally, we might think 2008 and 2009 are comparable. But in 1994, the internet had yet to be invented. Since then, as Austan Goolsbee and Peter Klenow estimate in "Valuing Consumer Products by the Time Spent Using Them: An Application to the Internet" (AER 2006) (gated) (ungated), the median individual gained $3000/year because of the advent (and widespread use) of the internet. The reason for this large gain is largely due to increased price competition and increased value of time. Since 1994, almost everyone in the United States is vastly better off than they were. (Another example might be how much individuals would have paid for a smart phone in 1994, given the millions that have them now and how "little" they paid for them relative for 1994 willingness-to-pay). This massive increase in consumer surplus generated from an increased value of time is unmeasured by GDP (underestimated) and poverty measures (overestimated). Use of these to compare long-run trends is ill-advised, especially when one has an ideological/Malthusian axe to grind.


Unfortunately, the notion that GDP growth generally underestimates utility gains is almost universally ignored in long-run intertemporal comparisons of utility.

L.A. city officials need to think twice about layoffs

Los Angeles Times opinion "L.A. city officials need to think twice about layoffs" (January 27th, 2010) provides an inconceivable suggestion. The article discusses unemployment in Los Angeles. It quotes a member of the mayor's office that suggests the mayor's office would print money to pay for full employment if it could.

Another senior member of the mayor's team, who asked not to be identified, put it this way: 'If we were the federal government, we'd simply print more money and keep everybody working, but we don't have that choice. People are your largest fixed cost in the public sector, and we don't have any choice but to reduce their number'"

If it wasn't in print today, Corrections would have believed that this sort of thinking died as its run grew long. The consequences of printing money to the Weimar Republic in 1923, Hungary in 1946, China in 1949, or Zimbabwe in 2004-2008 should have expelled this folly as a real consideration from the minds of all men.

Inflation is a monetary phenomenon.  When the government prints more money, makes it available, or credibly is expected to increase the money supply, higher prices result and the currency is devalued.  In the mean time, if money growth impacts transaction costs, as may happen when growth is very high, then real production may shift downward.  We would, for example, expect a shift to household production and other non-monetary activities.  We help create a sclerotic economy that further worsens our problems.

This is not, however, the end of our problem.  Were this the case, then we note that Tiebout sorting can take place--individuals with the most to gain from moving to a place or country with low transaction costs will be individuals who do the most activity in the marketplace.  This offers an additional loss to the sort of hyperinflation that the Los Angeles Times opinion editorial will bring about.