New York Fed Consumer Expectations Survey
Please consider the New York Fed Consumer Expectations Survey.
Median one- and three-year inflation expectations fell sharply in July, from 6.8% and 3.6% in June to 6.2% and 3.2%, respectively. Both declines were widespread across all income groups, but larger among respondents with an annual household income of less than $50,000 and among respondents with no more than a high school diploma. Median five-year inflation expectations, which have been obtained in the SCE monthly baseline survey on an ad hoc basis since the start of this year, also declined to 2.3% from 2.8% in June. Expectations for fuel and food price increases in the coming year have fallen sharply. Home price growth expectations and spending growth expectations for the year ahead have continued to decline from recent highs in the series. Household income growth expectations have improved.
For starters, bragging about a decline to 6.22% from the median one-year projections is nothing to brag about.
Even three years from now, 3.88% and 3.18% are well above the Fed’s target. The direction simply reflects the drop in gasoline prices at the moment.
So what? Inflation expectations are absurd
Inflation expectations are a ridiculous concept. Two independent Fed research papers draw this conclusion with precision.
Please consider Why do we think inflation expectations matter for inflation? (And should we?) by the Divisions of Research and Statistics and the Federal Reserve Board of Monetary Affairs.
The paper also castigated belief in the Phillips curve. Here are some direct quotes. The last point is the most important.
- Direct evidence of an expected inflation channel has never been very strong.
- It is an irony of history that when Phelps and Friedman sought to justify their proposed theoretical specifications, they were faced with the uncomfortable fact that the empirical Phillips curves appeared to be remarkably stable.
- These techniques are similar in spirit to those used in the 1990s to estimate New Keynesian models; therefore, they suffer from the same kinds of problems – discussed below – that accompany the empirical estimates of these models.
- Friedman’s derivation of the expectations-augmented Phillips curve implies that the real wage of the product should be strongly countercyclical (recall that in this model, firms are always assumed to be on their labor demand curves). In particular, Friedman actually states that “. . . the selling prices of products generally react to an unexpected increase in demand more quickly than the prices of the factors of production”, which would in turn imply the empirical prediction that the Phillips curve of prices is steeper than the curve of production. Phillips wages. However, in the US data, this prediction is completely at odds with the evidence.
- Most standard tests of the New Keynesian Phillips curve suffer from potential misspecification problems so severe or weak identification problems so deep that they provide no evidence one way or the other. importance of expectations (the same statement applies to empirical tests that use the survey). measures of expected inflation).
- What little we know about companies’ pricing behavior suggests that many tend to react to cost increases only when they actually arise and are visible to their customers, rather than preemptively..
Finding the Phillips Curve
Fed studies demystify the Phillips curve
Both studies were conducted by Fed staff members.
Yet Fed Chairs Janet Yellen and Jerome Powell did not believe the Fed’s own study.
in March 2017, Janet Yellen commented on the “Phillips Curve is Alive”.
If inflation expectations mattered
If inflation expectations mattered, the chart above would not exist.
Let it sink in.
From 2013 to 2021, inflation expectations averaged well above 3%. Even with the Fed pumping hard with QE, the Fed couldn’t get measured inflation above 2%!
How pathetic is that?
It’s not really the lack of inflation of course, but rather the way foolish economists see it.
Factoring in house prices and asset bubbles, there has been massive inflation, but not where clueless economists wanted it to be.
The Fed’s Second Study Concluded Inflation Expectations Theory Is Nonsense
Also consider that a Fed economist concludes that the widely held theory of inflation expectations is nonsense.
Here are some excerpts from the study itself:
Direct evidence of an expected inflation channel has never been very strong. Most empirical tests have been concerned with the proposition that there is no permanent compromise on the Phillips curve, in the sense that the coefficients of lagged inflation in an inflation equation were added to one.
Furthermore, most standard tests of the New Keynesian Phillips curve suffer from potential misspecification problems so severe or weak identification problems so deep that they provide no evidence one way or the other. another about the importance of expectations (the same statement applies to empirical tests that use survey measures of expected inflation).
What little we know about companies’ pricing behavior suggests that many tend to react to cost increases only when they actually arise and are visible to their customers, rather than preemptively..
It is much, much better and much safer to have a firm footing in nonsense than to venture over the murky seas of thought.. John Kenneth Galbraith (1958).
Few things are harder to bear than the annoyance of a good example. Mark Twain, The Tragedy of Pudd’nhead Wilson (1894)
One shouldn’t need a study to prove the obvious. And it is obvious that the theory of inflation expectations makes no sense.
The reason has to do with how inflation is calculated.
Scroll to continue
What can the Fed do about the price of food, medicine, gas, or rent?
On March 20, I asked What can the Fed do about the price of food, medicine, gas, or rent?
What the Fed Can and Cannot Do
- The Fed cannot directly influence the price of anything because it cannot produce goods or services.
- The Fed can reduce or increase demand when demand is elastic by raising or lowering the cost of money.
Elastic vs Inelastic Demand
- Elastic items only total 19.59%.
- Inelastic items total a whopping 80.41%.
This is why the theory of inflation expectations that the Fed abides by is complete nonsense.
People won’t rent two houses if they see prices going up. People also won’t stop paying rent and waiting for prices to come down because they think prices will come down.
The same goes for buying food, gasoline, etc.
Ingrained Stupidity: The Absurdity of Inflation Expectations in Graphic Form
I discussed the stupidity of inflation expectations theory in Stupidity Well Anchored: Absurdity of Inflation Expectations in Graphic Form
Questions and answers on inflation expectations
Q: If consumers think food prices will drop, will they stop eating out?
Q: If consumers think food prices will drop, will they stop eating at home?
Q: If consumers think the price of natural gas will drop, will they stop heating their homes and cooking to wait for the event?
Q: If consumers think the price of gas will drop, will they stop driving or not fill up their car if it runs dry?
Q: If consumers think gas prices will go up, can they do anything other than fill up more frequently?
Q: If consumers think the price of rent is going to drop, will they suspend renting until that happens?
Q: If consumers think the price of rent will go up, will they rent two apartments to take advantage of it?
Irony of Assets
People will rush to buy stocks in a bubble if they think prices will rise. They will hold off buying stocks if they expect prices to fall.
People will buy houses to rent or repair if they think house prices will go up. They will delay real estate speculation if they expect prices to fall.
The very things where expectations matter are the very things the Fed ignores.
Demand destruction will occur in the small subset of elastic items plus housing and inventory.
Except for recreation and restaurant dining, the rate hikes won’t affect food, energy or housing, the vast majority of the CPI.
Stupidity still entrenched
Here we are with Powell, Barkin and other Fed Chairs shining a light on expectations, having shrugged off the third massive stock market bubble in just over 20 years.
Meanwhile, “there is little doubt that the poor… are the main victims of inflation.”
Here’s the deal in a nutshell: The Fed actively promotes inflation while posing as inflation fighters. Yet people listen to these ignorant morons as if they know what they are doing.
It’s a good thing that inflation expectations are not self-fulfilling, as expectations took off in April.
Now they are crashing. It didn’t matter in April and it doesn’t matter now.
It seems crazy that economists can’t see the obvious, even when it’s repeatedly pointed out.
The reason is as stated above:”It is much, much better and much safer to have a solid grounding in nonsense than to venture out into the murky seas of thought. John Kenneth Galbraith (1958).“
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