Fool Risk Realized
Legendary football coach Bill Parcells once said, “you are what your record says you are.” It was a pearl of wisdom plucked from wherever Yogi Berra used to wander, made into a brutal truth delivered cunningly as a blatant tautology. We’ve all heard of how sports teams are “good on paper” or “better than their record”, but Parcells succinctly dismissed any such notions as not just bias but unhelpful bias. As he also once said,
You can’t dream up confidence. Confidence is born of demonstrated ability.
Over the last more than five years, the US CPI has met the Fed’s inflation target just eight times in those past 62 months. Five of those were recorded in just the last seven months, and they had nothing to do with greatest monetary team on paper.
US inflation, as it has around the rest of the world, has suddenly disappeared surprising no one apart from the media. The CPI for June was just 1.63% (NSA), right back about where it was conspicuously meandering last summer before all this began. It has been a very strange six months to say the least; to see what was a predictably short run change become turned into something it was so clearly not.
The real question is why. The oil price base effect was only ever going to be a huge tease, so long as oil prices remained at most steady. But you wouldn’t know it from anything in the mainstream, not the least policymakers who were crafty in their speeches and language, careful not to admit too much but more importantly never shattering the illusion.
It’s not as if oil was just recently stalled out. It has been going sideways for well over a year now, with the past four months a clear downward bias again. There was no other course for the CPI to take except back below the target. Why did Yellen’s Fed risk being made the fool yet again?
That’s clearly the position they have put themselves in, “raising rates” and refusing to clarify exactly why they are doing so. When the CPI, as well as the PCE Deflator if for only one month, was moving toward and above 2% there seemed for the first time since maybe the 1990’s some potential consistency. Now as the Fed still moves forward with its “exit”, all anyone wants to talk about is inflation. Where is it?
Yellen in particular is left to bumble about trying to blame unlimited wireless plans for all this. It is another “transitory” factor in a long line of transitory factors that leave only the specific excuses as transitory. I don’t particularly find the CPI or calculated inflation all that helpful an aggregate concept, but they do! It is one of the central pillars of monetary policy, and since 2012 the Federal Reserve has committed itself to a specific inflation target – which it cannot seem to meet no matter what it has done, or will do. A central bank that so explicitly cannot meet its own explicit standards is rightfully questioned for much more than mere consumer price indices.
Without knowing any specifics, for those we will have to wait another five and a half year for the full transcripts, I suspect the Fed embraced the danger of embracing the oil price effect for no other reason than a Hail Mary of rational expectations. Monetary policy is not in the slightest monetary, having been stripped down over the decades to little more than pop psychology; inflation expectations especially.
They really believe that if they can get people to believe inflation will be higher in the near future, people and businesses will act on those expectations today. The rise in the CPI was for the first time in years, I think in their minds anyway, a tangible bit of credibility that the average person could latch onto and think for once that it might actually happen. After all, they knew the CPI would be breathlessly reported over and over again as proof of economic renaissance (in the media in particular who were and are desperate to show all those populist uprisings were really illegitimate after all).
From the perspective of rational expectations, why spoil the party? Why not let the popular imagination run with it even if there was only ever a small chance it could work. Knowing full well it was temporary without rational expectations, we have to consider that officials chose to let it go that way because they were out of options. The growing tide of populist anger is going to be in history left as their true legacy, so if that was their last chance they had to take it. And it has, predictably, left them exposed as overconfident fools all over again. They are what their record says they are.