Inflation V

 

Rain

Shine, the weather's fine.
Can you hear me, that when it rains and shines,
(When the sun shines down.)
It's just a state of mind?

Is inflation just a state of mind?

There is a saying “ Everybody task about the weather, but nobody does anything about it.” ( This isn’t quite true. The Native American Tribes should get credit for their beautiful rain dances, even if they don’t always change the weather!)  But there is also the admonition, “First, do no harm”.  If you don’t understand inflation, then you should be cautious about taking an action to combat inflation.

Inflation seems to be defined as the Year Over Year inflation. For example, the Consumer Price Index, CPI, in the one month in 2022 compared to the Consumer Price Index in that same month in 2021. However that assumes that there is nothing strange in the CPI in the previous year.

There seems to be two problems with defining inflation this way. As someone who spent his career analyzing data, first shouldn’t the data be smoothed, and second shouldn't the period defining inflation be more than just a single year. There is a children’s story about Chicken Little (or Henny Penny for our English friends across the pond). Chicken Little says the sky is falling because an acorn has fallen on her head ( i.e. one piece of data for one point in time). Foxy Loxy plays along with her mistake and takes advantage of her.

What happens if we look at smoothing the CPI? First, looking at the unsmoothed CPI it looks like January 2021, February 2021 and March 2021 were well below the expected trend. Thus comparing March 2022 with March 2021 may not be the wisest thing to do. 

Smoothing the data, using a 5-year moving average (i.e.  the moving average of the current year is the average of the current year, the previous 2 years, and the following 2 years) presents a different picture. However before we get too excited about the higher than expected observed unsmoothed CPI in 2022, shouldn’t we wonder about the lower-than-expected reported and  unsmoothed CPI in March of 2020. LOL, was anything like a global pandemic happening in 2020 that was worth noting?

And before we get all excited about the observed and reported high CPI for March 2022, shouldn’t we wonder about the change in CPI that began in the early 1970s? It seems like it is larger and more ominous than the change from last year. I have blogged about my suspicions about what happened in the late 1970s https://dbeagan.blogspot.com/2021/07/money-supply.html and it appears to have a larger and more lasting impact on inflation than the recent changes. 

Before we do something about inflation, shouldn’t we understand more about inflation?