Friday, September 15, 2006

Caroline Baum misses the inflation target

Caroline Baum's piece on Bloomberg News today (U.S. Inflation Measure May Be Rotten at the Core) a deep misunderstanding of what inflation means to a macro economist. Its also exactly what I blogged about the other day.

Speaking about using core CPI because it eliminates two volatile prices, Baum says...

"It sounds nice, but when you think about it, it doesn't make sense. Taken at face value, Bernanke is saying the Fed would be happy to see inflation rise as long as the core rate doesn't budge from its comfort zone. Huh?"

Bernanke's job is to control the money supply. If the price of banana's quadruples because of a crop failure, that doesn't have anything to do with the money supply. If the Fed were to react to this isolated price change by raising rates to "control inflation," that would imply that the level of money depends partially on the quality of banana harvests. In the words of Caroline Baum, Huh?

Inflation is too many dollars chasing too few goods. It isn't CPI. It isn't PCE. Those are ways we attempt to measure inflation. If the Fed starts targeting gasoline prices to keep CPI down, then they are targeting a statistic, not actual inflation. That's like saying Kelly Holcumb is a better QB the Peyton Manning, because the former had a better completion percentage last year. Huh? Statistics are just ways we try to measure things. The statistic should never be an end of itself.

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