Fisher on Inflation

Dallas Fed President Richard Fisher came to the defense of core inflation in a speech today on "Inflation Measurement and Price Volatility." In doing so, he comes down firmly on the (correct) side of Brad DeLong and knzn in their slap-down of Barry Ritholtz and Dan Gross, who seem convinced that core inflation is some kind of conspiracy.

It is, of course, no such thing. The real reason that food and energy are ignored in core inflation is that, according to Fisher:

It boils down to what engineers call a "signal extraction" problem; struggling to eliminate "noise" in our monthly inflation measures and trying to maximize the amount of "signal." ... By ignoring items whose price movements display significant short-run volatility, statisticians and policymakers can get a better sense of underlying trends in consumer price inflation. Because the trends change only gradually, measures that give us a better sense of what they are today provide a better sense of where overall inflation will be tomorrow. To make inflation forecasts over the next 12, 18 or 24 months, we are much better off looking at the recent behavior of a core measure ... than we are looking at the recent behavior of headline inflation.

It really is just that simple. If you're interested in the debate, or if you have any sympathy for the Ritholtz/Gross view, do read the entire speech. It's a deeply informed, yet highly readable summary, and it's only 4 pages long. Plus you'll be treated to the rare event of a Fed speaker making a (kind of funny) joke.

For a deeper treatment of how to construct inflation measures that are better at predicting future headline inflation, read Measures of Core Inflation (pdf), by Julie Smith.

Finally, if knzn is reading this, Fisher must have read your proposal to target labor costs, rather than core inflation. Looks like that's not going to happen any time soon:

[T]here are macroeconomic models suggesting that if wages are stickier than prices, a central bank would do well to focus on an index of wages rather than prices. I just can't imagine central bankers lasting very long in their jobs if they continually announced to the public their desire to hold down wage growth.

Recommended Reading

Interview with Frederic Mishkin
The Region - Banking and Policy Issues Magazine
September 2007

In the Lap of the Gods
Speech by Richard Fisher, President of the Dallas Fed
Greater Dallas Chamber Annual State of Technology Luncheon
October 2, 2007

Fisher = Neutral Bias

Dallas Fed President Richard Fisher gave a speech today on education fittingly entitled "You Earn What You Learn," though he did spend a good part of it on monetary policy.

Fisher's speeches aren't usually subtle. There's usually nothing to read between the lines, so it doesn't really pay to over-analyze them. There are two parts I want to highlight, both basically speak for themselves.

Here's how he described last Tuesday's FOMC deliberations:

As we sat down to the FOMC table on Tuesday, we were faced with a situation that, drawing on my Naval Academy days, I would liken to a ship navigating a narrow passage between two shorelines.

On one shore, we have an otherwise healthy economy weakened to an unknown degree by a correction to excessive speculation in its housing sector and related financial instruments. On the price front, the economy has been experiencing mitigation in inflationary tendencies, thanks, I believe, to prudent monetary policy—albeit against a background of an energetic global economy that continues to create upward price pressures on all sorts of commodities, on transportation costs and even on what was once assumed to be an endless supply of cheap imports from China. If we had maintained the anti-inflationary course we had been following for more than 14 months by holding the fed funds rate at 5.25 percent, I believe we would have risked oversteering our course and potentially run afoul of the shoals of unacceptably slow economic growth. ... Recent trends in inflationary impulses and expectations, however, appeared to me to provide some wiggle room to adjust our tiller and steer a more growth-oriented course.

Looking to the other shoreline, we were confronting the rocky outcropping that economists call moral hazard. ... Overcorrecting our course with too aggressive a shift in the fed funds tiller would have, I believe, undermined the discipline that market forces impose upon wayward financial institutions and investors.

Fisher currently doesn't have a vote on the FOMC, but he will starting with the Jan 30, 2008 meeting.

The remainder of the speech was on education and the knowledge economy. Given that the UAW just went on strike today, this was particularly apt:

At the end of 2005, the U.S. auto and auto parts manufacturing industry employed about 1.1 million workers and added 0.8 percent of the value to our gross domestic product. The legal services sector employed nearly the same number but contributed 1.5 percent of the value added to GDP. In other words, lawyers produce twice as much as automobile workers. ...There is no more vivid demonstration of how services have replaced manufacturing as the engine of our economic prosperity.

It's also a good reminder that recessions in the future are unlikely to play out the way they have in the past.

P.S.: Bernanke also gave a speech on education today (Education and Economic Competitiveness), but, as has been his habit recently, he made no comment on monetary policy.

The Fisher Smackdown (9/10/07)

Richard Fisher, president of the Dallas Fed and current non-voter, gave a speech on Monday, nominally about The U.S., Mexican and Border Economies, though half the speech was about the U.S. economic outlook.

Before we get into this speech, a few words about his style: Fisher's speeches have this down-to-earth, straight-shooter, vernacular quality to them that I really like. He comes across as the kind of guy you'd want to have a drink with. I don't remember ever reading a dry speech from him. You can think of him as an everyman version of Janet Yellen. He also likes jokes and puns, which brings me to his current speech.

In recent weeks, we have heard much about financial market turbulence. We've been distracted by the noise of the subprime fallout, periodic reports of a "seizing up" in asset-backed commercial paper markets, volatility in the stock market and tremors in other parts of the financial infrastructure. (Apparently it is no longer true that, as Andrew Mellon once famously quipped, "Gentlemen prefer bonds.")

HA! You have to admit, it's not the Tonight Show, but for a Fed speech that's funny!

OK, now in all seriousness, here's Fisher's money quote:

Amidst this clamor and drama, some might have lost sight of our economy's great resiliency. ... Given the financial turmoil that began last month, I am generally encouraged by what I have heard and seen so far: As yet, tighter credit conditions do not appear to have had a major impact on overall economic activity outside of real estate.

So he'll be arguing for a 25bps, rather than 50bps, cut on Sept 18 (not cutting isn't really an option).

And now my favorite part. I may well just be projecting here, and he pulls it off with a completely straight face (at least on paper), but this looks to me like a much needed smackdown of that CNBC madman who accused the Fed of being "out of touch" and "asleep at the wheel."

As we approach the upcoming session of the FOMC, each of the participants, including me, is diving deep into the data and taking soundings from business leaders, bankers and others with operating ears to the ground to ascertain the current pace of the economy and—this is important—the prospective dynamics of growth and inflation. I am particularly active on this front. Before each meeting, I speak with around 30 CEOs and CFOs of a careful selection of large and small companies from around the country in order to get an in-depth understanding of the pace of economic growth and price pressures they see through their businesses. Meanwhile, our staff routinely surveys a broad base of businesses within our district and reports their findings in what is known as the Beige Book, the most recent of which was released last Wednesday. Lately, I have focused on how recent developments in financial markets are impacting the revenues and costs, supplier and customer dynamics, product mix and growth projections of these hands-on operators of our economy.... it is fair to say that I am encouraged by what I have heard against a background of constant negative speculation and the occasional discordant note, such as last week's employment numbers. Our economy appears to be weathering the storm thus far.

Booyah that, J.C.!