Monday, August 21, 2017

New Argument for a Higher Inflation Target

On, Philippe Aghion, Antonin Bergeaud, Timo Boppart, Peter Klenow, and Huiyu Li discuss their recent work on the measurement of output and whether measurement bias can account for the measured slowdown in productivity growth. While the work is mostly relevant to discussions of the productivity slowdown and secular stagnation, I was interested in a corollary that ties it to discussions of the optimal level of the inflation target.

The authors note the high frequency of "creative destruction" in the US, which they define as when "products exit the market because they are eclipsed by a better product sold by a new producer." This presents a challenge for statistical offices trying to measure inflation:
The standard procedure in such cases is to assume that the quality-adjusted inflation rate is the same as for other items in the same category that the statistical office can follow over time, i.e. products that are not subject to creative destruction. However, creative destruction implies that the new products enter the market because they have a lower quality-adjusted price. Our study tries to quantify the bias that arises from relying on imputation to measure US productivity growth in cases of creative destruction.
They explain that this can lead to mismeasurement of TFP growth, which they quantify by examining changes in the share of incumbent products over time:
If the statistical office is correct to assume that the quality-adjusted inflation rate is the same for creatively destroyed products as for surviving incumbent products, then the market share of surviving incumbent products should stay constant over time. If instead the market share of these incumbent products shrinks systematically over time, then the surviving subset of products must have higher average inflation than creatively destroyed products. For a given elasticity of substitution between products, the more the market share shrinks for surviving products, the more the missing growth.
From 1983 to 2013, they estimate that "missing growth" averaged about 0.63% per year. This is substantial, but there is no clear time trend (i.e. there is not more missed growth in recent years), so it can't account for the measured productivity growth slowdown.

The authors suggest that the Fed should consider adjusting its inflation target upwards to "get closer to achieving quality-adjusted price stability." A few months ago, 22 economists including Joseph Stiglitz and Narayana Kocherlakota wrote a letter urging the Fed to consider raising its inflation target, in which they stated:
Policymakers must be willing to rigorously assess the costs and benefits of previously-accepted policy parameters in response to economic changes. One of these key parameters that should be rigorously reassessed is the very low inflation targets that have guided monetary policy in recent decades. We believe that the Fed should appoint a diverse and representative blue ribbon commission with expertise, integrity, and transparency to evaluate and expeditiously recommend a path forward on these questions.
The letter did not mention this measurement bias rationale for a higher target, but the blue ribbon commission they propose should take it into consideration.


  1. Fucking stupid. The stagflationists, those who would target N-gDp and not R-gDp, simply don't know a credit from a debit. Reserve credits tend on average to precede reserve debits as evidenced by the existence of "float". Therefore it is a delusion to assume the non-banks can attract savings from the commercial banks for the funds never leave the payment's system.

    The way to increase R-gDp is to drive the DFIs out of the savings business, a velocity relationship.

  2. Monetary policy objectives should be formulated in terms of desired rates-of-change, roc's, in monetary flows, M*Vt (volume X’s velocity), relative to roc's in R-gDp. Roc's in N-gDp (though "raw materials, intermediate goods and labor costs, which comprise the bulk of business spending are not treated in N-gDp"), can serve as a proxy figure for roc's in all transactions, P*T, in Professor Irving Fisher's truistic: "equation of exchange".

    And Alfred Marshall's cash-balances approach (viz., a schedule of the amounts of money that will be offered at given levels of "P"), viz., where at times "K" is the reciprocal of Vt, or “K” has the dimension of a “storage period” and "bridges the gaps of transition periods" in Yale Professor Irving Fisher’s model. Roc's in R-gDp have to be used, of course, as a policy standard.

    Neither financial transactions not “animal spirits” are random:

    American, Yale Professor Irving Fisher – 1920 2nd edition: “The Purchasing Power of Money”:

    “If the principles here advocated are correct, the purchasing power of money — or its reciprocal, the level of prices — depends exclusively on five definite factors:

    (1)the volume of money in circulation;
    (2) its velocity of circulation;
    (3) the volume of bank deposits subject to check;
    (4) its velocity; and
    (5) the volume of trade.

    “Each of these five magnitudes is extremely definite, and their relation to the purchasing power of money is definitely expressed by an “equation of exchange.”

    “In my opinion, the branch of economics which treats of these five regulators of purchasing power ought to be recognized and ultimately will be recognized as an EXACT SCIENCE, capable of precise formulation, demonstration, and statistical verification.”

  3. There are 6 seasonal, endogenous, economic inflection points each year. These seasonal factors are pre-determined by the FRB-NY’s "trading desk" operations, executing the FOMC's monetary policy directives (in the present case just reserve "smoothing" and “draining” operations, the oscillating inflows and outflows, the making and or receiving of interbank payments).

    Every year, the seasonal factor's map (economic time series’ cyclical trend), or scientific proof, is demonstrated by the product of money flows, our means-of-payment money X’ its transaction’s velocity of circulation (the scientific method).

    Monetary flows (volume X’s velocity) measures money flow’s impact on production, prices, and the economy (as flows are driven by payments: “bank debits”). Rates-of-change Δ, in M*Vt = RoC’s Δ in AD, aggregate monetary purchasing power. Thus M*Vt serves as a “guide post” for N-gDp trajectories.

    N-gDp is determined by the volume of goods & services coming on the market relative to the actual, transactions, flow of money. Roc's in R-gDp serves as a close proxy to RoC's in total physical transactions, T, that finance both goods and services. Then RoC's in P, represents the price level, or various RoC's in a group of prices and indices.
    Monetary flows’ propagation, are a mathematically robust sequence of numbers (sigma Σ), neither neutral nor opaque, which pre-determine marco-economic momentum (the → “arrow of time” or "directionally sensitive time-frequency de-compositions").

    For short-term money flows, the proxy for real-output, R-gDp, it's the rate of accumulation, a posteriori, that adds incrementally and immediately to its running total. Its economic impact is defined by its rate-of-change, Δ "change in". The RoC, is the pace at which a variable changes, Δ, over that specific lag's established periodicity.

    As Nobel Laureate Dr. Ken Arrow says: “all analysis is a model”.

  4. Long-term money flows:

    1/1/2017 ,,,,, 0.19
    2/1/2017 ,,,,, 0.16
    3/1/2017 ,,,,, 0.13
    4/1/2017 ,,,,, 0.18
    5/1/2017 ,,,,, 0.23
    6/1/2017 ,,,,, 0.21
    7/1/2017 ,,,,, 0.17
    8/1/2017 ,,,,, 0.24
    9/1/2017 ,,,,, 0.25 peak in commodities
    10/1/2017 ,,,,, 0.25
    11/1/2017 ,,,,, 0.22
    12/1/2017 ,,,,, 0.15
    1/1/2018 ,,,,, 0.21
    2/1/2018 ,,,,, 0.21
    3/1/2018 ,,,,, 0.18
    4/1/2018 ,,,,, 0.15
    5/1/2018 ,,,,, 0.15
    6/1/2018 ,,,,, 0.13

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