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December 2, 2010
What might monetary policy success look like?
As 2010 nears its end, my colleagues and I are beginning the process, familiar to organizations public and private, of evaluating performance in the past year and setting goals for the year ahead. In that process, one question is pressed: What does success look like?
It is a good question for monetary policy, and one I touched on a couple of posts back. As in that post, I'll cite my boss, Atlanta Fed President Dennis Lockhart from his Nov. 16 speech in Montgomery, Ala.:
"In my mind, the perceived risks—particularly the risk of overshooting inflation—must be weighed against the risks that could be associated with a policy of inaction. Chief among those risks is a recessionary relapse possibly tipping into a long spell of deflation. Through the summer there were some signs of renewed disinflation, which could lead to deflationary expectations taking hold.
"I think it is important to stress that our experience in dealing with inflation versus deflation is not symmetric. In the event of a policy overshoot, inflation containment requires the implementation of the mostly familiar strategy of raising short-term interest rates. In the event of an undershoot, however, dealing with a deflationary spiral and the attendant real consequences would be far less familiar territory for policymakers."
So, in President Lockhart's view, there is the statement of objective—insurance against an unwanted deflationary spiral. And the measure of success? Again from President Lockhart, as quoted in my previous post:
"In regard to price stability, this policy has already shown some signs of success by altering inflation expectations and reducing the risk of unwanted disinflation. To explain, inflation expectations extracted from Treasury inflation-protected securities, or TIPS, spreads over like-duration Treasury securities were declining persistently over the course of late spring through summer.
"Following the August 27 Jackson Hole speech by Fed Chairman Ben Bernanke, these spreads have recovered to previous levels. In addition, according to analysis we've done at the Atlanta Fed, deflation probabilities reflected in TIPS have fallen from the high levels prior to the September FOMC meeting."
Those deflation probabilities were described in an earlier macroblog post, and if you are looking for a measure of success, here is a picture:
As of today's update, these probabilities have fallen to the levels observed prior to the economy's summer soft patch. Importantly, the deflation probabilities have retreated without a movement of straight inflation expectations outside of bounds that are (arguably) consistent with what Chairman Bernanke has described as "the mandate-consistent inflation rate."
Of course, the full story has yet to be written. But it looks like a promising start to me.
Note: The deflation probabilities mentioned in the blog are published weekly as part of the Atlanta Fed's Inflation Project. For a description of inflation expectations, measured as the breakeven rates calculated from TIPS yields, see this article from the Federal Reserve Bank of San Francisco.
By Dave Altig, senior vice president and research director at the Atlanta Fed
July 9, 2010
How close to deflation are we? Perhaps just a little closer than you thought
Since last October, the consumer price index (CPI) has gone up an annualized 0.7 percent. On an ex-food and energy basis, the number is a little lower, at 0.5 percent. And the Cleveland Fed's trimmed-mean and median CPIs, at 0.7 percent and 0.2 percent, respectively, also put the recent trend in consumer prices in pretty low territory.
And this is before we take into account any potential mismeasurement, or "bias," in the construction of the CPI.
How big is the CPI's bias? Well, in 1996, the Social Security Administration commissioned a study on the accuracy of the CPI as a measure of the cost of living. This so-called "Boskin Commission Report" said the CPI was overstated by about 1.1 percentage points per year. The commission identified several sources of potential bias, but about half of the 1.1 percentage points resulted from new products and quality changes that were slow or otherwise imperfectly introduced into the price statistic.
Since that time, the Bureau of Labor Statistics has initiated a number of methodological changes that have reduced the CPI's mismeasurement. In a 2001 paper, Federal Reserve Board economists David Lebow and Jeremy Rudd put the CPI bias at only about 0.6 percentage points. And again, of this amount, the big share of the bias (about 0.4 percentage points) resulted from the imperfect accounting of new and improved goods.
Now, in an article (available to all in its working paper version) appearing in the latest issue of the American Economic Review, Christian Broda and David Weinstein say the earlier estimates of the new goods/quality bias may be a bit understated. The authors examine prices from the AC Nielsen Homescan database and conclude that between 1996 and 2003, new and improved goods biased the CPI, on average, by about 0.8 percentage points per year. If this estimate is accurate, consumer price increases since last October would actually be around zero, or even slightly negative, once we account for the mismeasurement of the CPI caused by new and improved goods.
But (oh, you just knew there was going to be a "but" in here, right?) the authors also point out that, because new goods are introduced procyclically, this bias tends to be larger during expansions and smaller during recessions. In other words, given the severity of the recession and the modest pace of the recovery, there may not be a whole lot of innovation going on right now in consumer goods. This is a bad thing for consumers, of course, but it would be a good thing for the accuracy of the CPI.
By Mike Bryan, vice president and senior economist at the Atlanta Fed
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