The Rent, Gas & Groceries Are Too Damn High

A week ago, Rex Nutting had an article at MarketWatch entitled, "The only things going up in price are the bare necessities". The article was subtitled, "With wages flat, many workers are running to stay in place". 

For the Federal Reserve, inflation isn’t much of a problem.

Prices are going up at a moderate pace of around 2.5% per year. Stripping out food and energy (which is the right way to do it when you’re predicting future inflation), prices are up 2.1%.

The Fed knows the economy works best when there’s a little inflation, and that’s what we have when you look it from 35,000 feet. If the Fed could freeze the economy right where it is now, it would.

To me the most fascinating phrase in the opening paragraphs is the parenthetical "which is the right way to do it when you're predicting future inflation". Why exactly does Mr. Nutting and basically everyone else believe that is true? Why is inflation minus food and energy "the right way to do it"?

Inflation ex-food and energy is known as "core" inflation and as Mr. Nutting points out, it is what economists believe to be important. Basically, economists believe that commodity prices are too volatile and too unpredictable to control and if you attempt to do so, you will create other problems in the economy. That is probably true when looking at any individual commodity. Attempting to run monetary policy by controlling the price of, say, corn does seem a pretty terrible idea. A drought could cause a depression. Oil prices, by themselves, would also seem a pretty poor guide to monetary policy.

But how can core inflation exclude food and energy? Call me crazy but food and energy are core for most American families. If you add housing that pretty much covers the core - assuming you are using a normal definition of the term, i.e. basic, essential. 

A few years back William Dudley, the now former head of the NY Fed, gave a speech in Queens. He spent his speech patting himself and his fellow central bankers on the back for keeping inflation under control. During the Q&A session though he got an earful:

“When was the last time, sir, that you went grocery shopping?” one audience member asked.

Dudley tried to explain how the Fed sees things: Yes, food and energy prices may be rising, but at the same time, other prices are declining.

“Today you can buy an iPad 2 that costs the same as an iPad 1 that is twice as powerful,” he said.”You have to look at the prices of all things.”

This prompted guffaws and widespread murmuring from the audience, with one audience member calling the comment “tone deaf.”

“I can’t eat an iPad,” another said.

Why does monetary policy today seek to stabilize the price of luxuries while essentially ignoring the fluctuating prices of the basic necessities? Mr. Nutting blames this on a lack of wage growth and worries that the Fed will hit the monetary brakes before wage inflation allows workers to catch up. The problem with that line of thinking is that in today's hamster wheel monetary system, they will never catch up. 

Maybe, the audience in Queens has it right and the economists have it wrong. Maybe, the Fed should be judged by how well it controls the prices of the necessities. Believe it or not, they actually have the ability to do that.  There have been periods in our past when the necessities of life barely budged in price. We know how to reduce the volatility of commodities. It's called a gold standard and when we've been on it the volatility of commodities was much less.

From 1880 to 1913, when the Fed was established, the standard deviation of commodity prices was roughly 4.5%. During the free float period before and after WWI, the standard deviation doubled (at least; there are differences depending on which commodity index you use). During the Bretton Woods era from 1945 to 1971 commodity price volatility was again reduced to a standard deviation of about 8%. Since 1971, volatility has again risen to at least 15 (and again, at least; the GSCI has a standard deviation over 20).

Furthermore, when you look at specific commodity prices, there are many examples of prices not moving at all over decades or in some cases falling. Now, I know that everyone, even Mr. Nutting above, believes that "the economy works best when there's a little inflation" but that is a "fact" based on one episode in history, the Great Depression. Going from "we had deflation during the Great Depression" to "all deflations cause economic depressions" is quite a leap and one that doesn't stand up to scrutiny.

The iPad example Mr. Dudley used is a great example. Why do economists applaud a drop in the price of an iPad or computers or cell phones? They do because creating more and better things with less is what capitalism is all about. It's called productivity and is the very essence of economic growth. So, how could something that is the most basic outcome of capitalism, something cheered by economists everywhere, be vilified when it occurs in the aggregate? Are those who say that deflation should be avoided at all costs implying that capitalism itself is the problem? Do they believe that rising productivity caused the Great Depression? I suppose that may be true of some but certainly not for most. 

It would seem that there are good forms of deflation and bad. Bad deflations are like the one that hit during the Great Depression and are monetary in nature, an actual contraction of the money supply. That is certainly a bad and should be avoided. But there is also good deflation, that provided through gains in productivity such as that improved iPad selling for the same or less than the old, inferior one. That kind of deflation should be applauded.

There is an ongoing debate in this country about inequality and its causes and effects. As many others have pointed out, monetary policy plays a role here too but the more recent argument has been that QE or other modern forms (actually not that modern but that's a different discussion) of monetary policy are to blame. But maybe the problem is more basic than that. I hear a lot of people say the economy of the post WWII era was more fair and I think they are right but the most common solutions involve coercion, a forced redistribution from one group of Americans to another. Not only does that not address the problem, it will just further divide our already splintered body politic.

I think we need to have a debate about the goals of monetary policy. Should we continue to have a monetary policy that favors the wealthy and banks over average Americans? That is really what we've been doing whether we admit it or not. Or should monetary policy look first to stabilize the prices of the bare necessities? Do you really want to argue the pro rich, pro bank side of that argument? Does it even make sense? It doesn't to me. 

I don't know if we can accomplish the goal of a stable dollar and more stable commodity prices without a gold standard. I'm not even sure we want to; there were still monetary problems under a gold standard although it may be that, like democracy, it is the worst system except for all the others that have been tried from time to time. Maybe we could use a more general commodity index or add some element of asset prices to the Fed's mandate. I don't have the answer. But I'm damn sure that what we are doing now is unfair and ineffective. As someone said a few years back, the rent is too damn high. I'd add gas and groceries to that list.