"It Is A Battle Between Data And Theory" - Fed PhDs Second-Guess Inflation Model After 5 Years Of Failure

Federal Reserve officials are finally waking up to the fact that there’s something wrong with their inflation models. It only took them five years.

As Bloomberg points out, the minutes from the Fed’s July policy meeting, released yesterday, included a debate about whether the models that help the central bank set its inflation target are no longer functioning properly.

“Federal Reserve officials are looking under the hood of their most basic inflation models and starting to ask if something is wrong.


Minutes from the July 25-26 Federal Open Market Committee meeting showed a revealing debate over why the economy isn’t producing more inflation in a time of easy financial conditions, tight labor markets and solid economic growth.


The central bank has missed its 2 percent price goal for most of the past five years. Still, a majority of FOMC participants favor further rate increases. The July minutes showed an intensifying debate over whether that is the right policy response.”

Some economists worry that if the Fed begins to publicly question their methods, it could ruin what little credibility the central bank has left.

“These minutes to me were troubling,” said Ward McCarthy, chief financial economist at Jefferies LLC in New York. “They don’t have their confidence in their policy decisions; and they don’t have confidence that they can provide the right kind of guidance.”

Of course, Fed officials did everything in their power to communicate that these questions were being raised by a small minority on the FOMC, and didn’t represent anything resembling an official opinion.

“In several passages, the minutes asserted that “most” officials were sticking with a forecast that higher inflation would eventually show up. However, the debate over resource slack models and whether standard data sources were telling them the whole story also showed convictions about their forecast are fraying.”

As Bloomberg explains, prices have been resistant to any upward movement even as the US unemployment rate has fell to a 16-year low of 4.3 percent in July. The U.S. consumer price index rose 1.7 percent for the 12 months ending July, while the PCE price index, the Fed’s preferred measure, which is tied to consumption, rose 1.4 percent in June. Another gauge calculated by the Dallas Fed, which trims index outliers to highlight the underlying price trend, rose 1.7 percent for the 12 months ending June. That was the same as May, which was down from 1.74 percent in April.

A few officials pointed out what many investors have believed for years: That the Fed's inflation forecasting model is totally useless.

“The minutes said “a few” officials described resource slack models as “not particularly useful” while “most” thought the framework was valid.


Members also questioned whether there’s another theory that might better explain the inertia in prices.


The committee also pondered a number of theories as to why inflation wasn’t responding to tightening labor resources, such as “the possibility that slack may be better measured by labor market indicators other than unemployment.”

One notable economist described it as “a battle between data and theory.”

“It is a battle between data and theory,” said Ethan Harris, head of global economic research at Bank of America Corp. in New York.

But it almost doesn’t matter that the Fed’s vaunted inflation models no longer make any sense, because, the Fed is going to keep hiking no matter what now that the risks have struck the “appropriate balance” – at least that’s what one member of the leadership (probably Chairwoman Yellen) believes.   

“The minutes also included an unusual signal that someone - possibly a member of the committee’s leadership - saw additional rate increases as striking the “appropriate balance” on policy goals, dedicating two sentences to the views of “one participant.”


“That seems like an awful lot of air time as well as a very definitive answer coming from a mere ‘one participant’ - unless that single person happened to be someone really important - like, I don’t know, maybe the Chair?,” Stephen Stanley, chief economist at Amherst Pierpont Securities in New York, wrote in a note to clients, referring to Janet Yellen.”

Maybe in whatever model they concoct to replace this one, the Fed should include a metric probably more relevant today than economists realize: The amount of time Americans’ spend on Instagram per day.


gouyou quebecgold Thu, 08/17/2017 - 23:27 Permalink

One other aspect to take into consideration is the death of retail and the rise of e-commerce in general and amazon in particular.When people can effectively compare dozens of products and prices in seconds, it fosters competition on prices and quality levels, logically keeping prices in check. The death of retail is also the death of inflation. You can't simply mark up prices any longer, people are just going to switch to the next product.

In reply to by quebecgold

froze25 (not verified) gouyou Thu, 08/17/2017 - 23:47 Permalink

We aren't solely talking price inflation we are also talking wage inflation,  that can happen in a time of price stability or deflation but only if the means of production (source the raw materials and or manufacturer the good) are taking place where the item is sold. With out also having those value adding steps wage inflation won't happen.

In reply to by gouyou

auricle GUS100CORRINA Fri, 08/18/2017 - 03:07 Permalink

They are trying to make the runaway train look like it's not running away. Those exploding prices are not real. Just wait till they substitute aqua bounty GMO fish into the inflation metrics. They'll be claiming salmon costs $5/lb and not $26/lb for wild caught. Soon it will be done for lab grown beef and so on. All their econometrics are nothing but snakeoil.

In reply to by GUS100CORRINA

Iskiab GUS100CORRINA Fri, 08/18/2017 - 17:35 Permalink

I agree with this (shadowstatistics post). If you fuck with how a statistic is calculated enough then no wonder your model stops acting as expected.

The other part is a lot of economic theory is based off observations, cooberated with analysis for validity. If the economy changes then the theory stops working. It's the classic correlation does not mean causation.

The reason why there's an argument about the theory is some people have benefited a lot from these economic theories. To abandon them means the money stops flowing so some will hold onto them and try and ignore data/common sense.

In reply to by GUS100CORRINA

Golden Showers Thu, 08/17/2017 - 22:49 Permalink

In a world... where data and theory collide in epic battle... One man had the courage to laugh. This is his story.Data and theory, eh? So, that means that the numbers don't match the models. So which do YOU think is wrong? Is it the numbers, the models, or the metrics?Only Fed PhD can't figure this bullshit out. The guy on the street knows what time it is.

The Wizard Golden Showers Thu, 08/17/2017 - 23:41 Permalink

The models are reflecting a fantasy, not reality. Because of this reality has become a fiction.How many econometric models factor in variables for the manipulation of markets?When I ask people, how's it going, they tell me they are living the dream. I tell them I would like to correct that to: We are living in a dream.The Real Matrix Is … Still Realhttps://newswithviews.com/the-real-matrix-is-still-real/ 

In reply to by Golden Showers

Ignorance is bliss Thu, 08/17/2017 - 22:53 Permalink

Hmm. Based on this news you should be buying gold ASAP if you don't already own it. The Fed knows the system is failing in key areas and their trying to figure out why their models are fucked up. I make a pretty good living and I'm feeling the inflation pinch. I can't imagine how the average guy making $45k a year does it.

froze25 (not verified) Ignorance is bliss Thu, 08/17/2017 - 23:59 Permalink

Add having kids with no family (parents) to assist with child care to that. To use a "licensed" daycare for a 0-2 year old is about 1600 a month 2 -3 year old better but about 1450. I ask myself how the hell the lower paid people do it regularly.Meanwhile there is a nice group in the population that I get the pleasure of paying for them to have kids, medical,  daycare, simply because they don't wish to be responsible and carry their own weight and pay for their own responsibilities. 

In reply to by Ignorance is bliss

Yen Cross Thu, 08/17/2017 - 22:55 Permalink

  Even the pinheads on the news stations are starting to discuss the divergence between hard and soft data.  You have these assclown "wealth management" fossils trying to justify the ROI on Treasuries vs equities, and you know they're just cashing out, and running for the hills.

HRH Feant2 (not verified) Thu, 08/17/2017 - 22:56 Permalink

Have they talked to the guy that runs Shadowstats? That might help. 22% unemployment and 93 million people out of the labor force might help them fill in a few blanks.

Jeezus someone needs to lean a ladder next to the ivory tower these dipshits are living in so they can climb down and breathe the same air as the unwashed masses!

Freedumb Thu, 08/17/2017 - 22:57 Permalink

Laying a nice thick foundation for later deniability that the Fed could have foreseen anything that went wrong rather than that they deliberately and directly caused our economic doom.

TheMexican Thu, 08/17/2017 - 22:59 Permalink

These people never cease to amaze me with their bullshit.
I left San Diego in 2004 because everything was getting way too expensive. $5 for an Tropicana orange juice with ice.

$500,000 shack by the beach.

Adios motherfucker!

small axe Thu, 08/17/2017 - 23:05 Permalink

the Fed theorists would figure it out real quick if they ever had to balance a checkpoint, buy groceries, or find a job that produced anything other than high-quality tripe with which to distract a gullible public.

ReturnOfDaMac Thu, 08/17/2017 - 23:07 Permalink

Freaking boneheads.  Their models are less useful than reading chicken endtrails.  The problem is obvious, V=0.  Its dead Jim.  Velocity of money is 0. Numbnuts, all.  Its zero because it's in the hands of a few pigmen who don't need to spend it in the real economy.  Buying and selling stawks, although it makes me money, it does not help the economy.  If you want to make V get off the ground, let the price of gold hit say $6K ~ $10K.  You'll see V get it up like a teenage boy on viagra.  Problem solved.

Yen Cross Thu, 08/17/2017 - 23:16 Permalink

  I read an article earlier. I want you people to really understand the magnitude, of what Tyler shared with us.  Thirty Four Percent of "stated Chinese debt" can't be collateralized. [doesn't exist]   This is massive, and amounts to all fed debt, and 1/2 of ECB stated debt.  [so we're talking about >in< $usd 6.5 trillion in unaccountable collateral.  How can you even begin to compare equities with treasuries, when equities are rehypothecated at multiples, of [unaccounted for, actual collateral]  Bond's are priced normally, and equities are snake oil sell side scum! 

Bret Bear (not verified) Thu, 08/17/2017 - 23:35 Permalink

WOW getting desperate for a new spin huh? The only guys on the hedge who are calling the markets right is the Shepwave followers. Thanks guys. Keep it up!

fuckstar Fri, 08/18/2017 - 00:02 Permalink

They have the perfect proportion of quotas. Merit and accountability is not required. They never have to show their work. What could possibly go wrong?

chosen (not verified) Fri, 08/18/2017 - 01:26 Permalink

Inflation is way up if you rent or own a house.  I suppose if you live under a bridge, inflation is fairly flat.