Sunday, May 05, 2013

Weekly Roundup

If any of you are puzzled by the low inflation rate, consider that in 2005, the Fed convinced themselves that house prices weren't in a bubble because a hedonically adjusted housing price index showed little movement. Sort of like our consumer price indices.  From a Federal Reserve meeting that focused on home price appreciation circa 2005:
For example, over the four years from 2000 to 2004, the OFHEO index increased at a compound annual rate of 8.2 percent, while the constant-quality index increased at a 5.4 percent annual rate. As shown in exhibit 4, the current ratio of price over median family income derived from these two indexes is vastly different. If the OFHEO index is giving an accurate picture of what is happening to home prices, I think one could say with some confidence that prices have been bid up to unsustainable levels. However, if the constant-quality index is a better reflection of reality, home prices actually look somewhat low relative to median family income, particularly compared to the late 1970s. I believe the constant quality index provides a more accurate indication of what is happening to the price of a typical single-family home. In contrast, the OFHEO index is subject to upward biases that accumulate over time and distort ratios such as price-to-income and income-to-rents.
Clearly, that real estate adjustment wasn't helpful. Perhaps our current CPI is similarly biased? That is, if you used 1990's CPI methodology, inflation would be around 5%, and using 1980's, it would be 10% (see here). Were we wrong then, or now?
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Joseph Stiglitz has the following take-away from current events:
The big lesson that this crisis forcibly brought home—one we should have long known—is that economies are not necessarily efficient, stable or self-correcting.
Gee, that's what the latest data say? He has been saying that since he edited Samuelson's papers in 1970: markets are not efficient.  His life's work has been on that theme, as his Greenwald-Stiglitz theorem posits market failure as the norm, and his Sappington-Stiglitz theorem suggests that an ideal government could do better running an enterprise itself than it could through privatization.

I've never seen him seriously address government failure, other than the stupidity of IMF personnel, who he noted were rarely top students from Harvard, Oxford, or Princeton. If he thinks second-rate Yalies have negative productivity, what about your typical bureaucrat?

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Niall Ferguson's remark that Keynes's childlessness influenced his dismissive perspective on the long run created quite a firestorm, including a rather pathetic apology that will only encourage his enemies.  I remember reading a Keynes biography around 1988 and the author's theme was that homosexuality was the key to why Keynes thought 'outside the box.'  I personally doubt his homosexuality was so tenuously related to his economics it's hardly worth much thought, though perhaps it would rise to be worthy of an aside at a luncheon.

Diversity is supposedly this great thing because various minorities have different perspectives, why demographics have systematic predilections towards various parties and issues.  It seems a matter of pure logic to accept that if  different backgrounds can generate positive attributes, some could be negative, but if you ever say that you are a bigot.

I'm not anti-gay, and sympathize with their uniquely difficult coming out issues.  Yet, I'm not sympathetic to the idea that if one asserts any negative consequence of being gay, it's homophobia. I see this as an example of the Left showing its power and making sure that issues it categorizes as taboo stay taboo.
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The latest low volatility continue to show the benefits of low volatility this year.


Any way one would make a low vol portfolio--volatility, minimum variance algorithm, beta--generates the same results. See betaarbitrage.com for the data.

Asness, Frazzini and Pedersen have an important paper countering Ronnie Shah of Dimensional's assertion that low volatility is an industry result. It isn't.

Kevin Simler has some thoughts on the economics of status.  He basically argues it's very important and omnipresent. Never mentions the effect on risk premia, though I expect he wouldn't go that far.    That is, status seeking is accepted by economists at explaining parochial things, but somehow it disappears when it comes to addressing risk premiums, or welfare analysis.

15 comments:

Unanimous said...

With regard to minority views being positive, I don't think that anyone thinks or says that all different perspectives are positive. For example, if you say that modern NAZI views are negative, on the whole you won't be accused of being a bigot.

Diversity is supposedly a good thing because once larger consideration is given to the various perspectives, aspects of the views can be co-opted and become part of the mainstream. All mainstream views started off as minority views. If you remove diversity, you will remove the mainstream's ability to improve. This is quite consistent with most minority views being wrong or counter productive. Your views on this seem quite strange for someone who spends quite a bit of time expressing minority views.

Also, Kevin Simler's post is very interesting. Worth a read. Not sure I agree with it all, but definitely another minority view point worth considering, many parts of it could well become mainstream.

Garrett M said...

So according to shadowstats, inflation from 2005-2008 was on the same level as 1980-1982? Admittedly I wasn't alive in the early 80s, but does that make sense to anyone who was?

Also if you want to talk about the rental adjustment in CPI covering up the increase in housing prices, then you should consider that CPI would've been much more negative in 2009 without the rental adjustment and we'd be far below the trend level right now.

Anonymous said...

I am utterly dismayed to see the Shadowstats website get *any* sort of positive light from such an otherwise excellent mind. Those numbers were utterly destroyed by an MLR article a few years back, written by Greenlees and a coauthor. Furthermore, a single hedonic index for homes should not be compared to the CPI, which has thousands of prices and well-vetted methodology underlying every single intermediate number.

Randy

cig said...

Once you admit that most economic activity is about status, why not measure inflation on the income side: the average or median income (or wage) should be the thing that monetary policy aims at keeping stable in nominal currency units.

This would nicely circumvent any issues with calculating price-based inflation (hedonic adjustment on houses may be a problem, unlike regular products, precisely because they are status/positional goods more than they are machines to live in).

yoyodyne said...

The Shadowstats data is absurd, he also claims real GDP in the US peaked in the early-to-mid 1990s.

In 1999, the CPI change to a geometric mean was used because it is more accurate, but this is the most misunderstood and misreported change.
http://www.bls.gov/cpi/cpiqa.htm

'Common Misconceptions about the CPI:
The CPI used to include the value of a house in calculating inflation and now they use an estimate of what each house would rent for -- doesn't this switch simply lower the official inflation rate?

No. Until 1983, the CPI measure of homeowner cost was based largely on house prices. The long-recognized flaw of that approach was that owner-occupied housing combines both consumption and investment elements, and the CPI is designed to exclude investment items...However, when it was first introduced, rental equivalence actually increased the rate of change of the CPI shelter index, and in the long run there is no evidence that the CPI method yields lower inflation rates than some other alternatives. For example, according to the National Association of Realtors, between 1983 and 2007 the monthly principal and interest payment required to purchase a median-priced existing home in the United States rose by 79 percent, much less than the rental equivalence increase of 140 percent over that same period...

Furthermore, if the CPI were using the pre-1983 asset-based method instead of rental equivalence to measure homeowner shelter cost it would yield a sharply lower current measure of shelter inflation...'

When the cost of food rises, does the CPI assume that consumers switch to less desired foods?

No. In January 1999, the BLS began using a geometric mean formula in the CPI that reflects the fact that consumers shift their purchases toward products that have fallen in relative price. Some critics charge that by reflecting consumer substitution the BLS is subtracting from the CPI a certain amount of inflation that consumers can "live with" by reducing their standard of living. This is incorrect...Specifically, in constructing the "headline" CPI-U and CPI-W, the BLS is not assuming that consumers substitute hamburgers for steak. Substitution is only assumed to occur within basic CPI index categories, such as among types of ground beef in Chicago. Hamburger and steak are in different CPI item categories, so no substitution between them is built into the CPI-U or CPI-W.
Furthermore, the CPI doesn't implicitly assume that consumers always substitute toward the less desirable good. Within the beef steaks item category, for example, the assumption is that consumers on average would move up from flank steak to filet mignon ...

In using the geometric mean the BLS is following a recognized best practice for statistical agencies.

Is the use of "hedonic quality adjustment" in the CPI simply a way of lowering the inflation rate?

No. The International Labour Office refers to the hedonic approach as "powerful, objective and scientific". Hedonic modeling is just one of many methods that the BLS uses to determine what portion of a price difference is viewed by consumers as reflecting quality differences.
Many of the challenges in producing a CPI arise because the number and types of goods and services found in the market are constantly changing. If the CPI tried to maintain a fixed sample of products, that sample quickly would shrink and become unrepresentative...
Critics often incorrectly assume that BLS only adjusts for quality increases, not for decreases, and that hedonic adjustments have a large downward impact on the CPI. On the contrary, BLS has used hedonic models in the CPI shelter and apparel components for roughly two decades, and on average hedonic adjustments usually increase the rate of change of those indexes...hedonic models currently used in the CPI outside of the shelter and apparel areas have increased the annual rate of change of the All Items CPI, but by only about 0.005 percent per year.'

Eric Falkenstein said...

I don't follow CPI construction closely, so I could very well be quoting a crank with that alternative CPI measure. Yet, I'm skeptical of quality adjustments, which is why I noted it.

As for diversity ignoring nazis, good point. Diversity is only good when incorporated historically disadvantaged minorities, supposedly. Obviously, I think it's all a crock, because everything's a multitude, with pros and cons.

Wall Street Fool said...

The Core CPI is a Farce... Why do we even have that, is beyond me...add that to the centrally inflated stock markets and suppressed yields.... we have a perfect recipe for disaster...

http://wallstreetfool.com/2013/05/03/letter-to-central-bankers/

LeonK said...

1. Mood affiliation - shadowstats is garbage.
2. Leftist mood affiliation (and actually a humorous juxtaposition with #1).
3. Ferguson's remarks were remarkably ill-informed on their own merits. Keynes eventually tired of homosexuality and took a wife - who suffered two miscarriages. Keynes started to come up with "The General Theory" around the end of 1929 by which time most (all?) of his gay affairs had concluded. Sociologists/cog sci guys have been listing downsides of diversity for years (Putnam's diversity research and the Collective Intelligence stuff at MIT).
4. Low vol stuff is excellent as always.

@Wall Street Fool
Core CPI predicts future CPI better than current CPI.

AHWest said...

Eric,
Thanks for the weekly update. I enjoy reading your opinions, because I often agree with them (confirmation bias) and other times, because they're new and important.

Anonymous said...

It never ceases to amaze me when public figures come out with very public statements that will so obviously force them to later apologize for it. Any half-wit could have told Ferguson he was going to sow a shitstorm for that comment.

Anonymous said...

Sorry, reap, not sow...

Anonymous said...

would someone kindly post a link the the articles disproving the Shadow Shit guy I would greatly appreciate it.

Mercury said...

Here's some red meat EF:

http://libertystreeteconomics.newyorkfed.org/2013/05/are-stocks-cheap-a-review-of-the-evidence.html

Plenty of circular reasoning and hubris.

Anonymous said...

OK anonymous:

http://www.bls.gov/opub/mlr/2008/08/art1full.pdf

randy

PS the working paper version was better, they had to cut out a lot of the sharp criticsm. Maybe you could contact one of the authors.

Mercury said...

Hedonic adjustments are sketchy at best. You may be getting a lot more bang for your TV buck than you were 10 or 20 years ago but what do you think the hedonically adjusted cost of the average US college degree is 1980 vs. 2012?

Also the rental equivalence metric has always been a joke as it is based on knocking on people’s doors and asking them what they think they can rent their house for. Obviously most people have no clue, no data points to work from or any inclination to ever do such a thing.

The government is pretty open about wanting to adjust SS COLAs to levels that are below actual annual inflation rates so it’s not out of the question that they would prefer to have CPI itself understate inflation.