Prediction about Future of Inflation
The Phillip’s curve is obsolete. Inflation does not reliably depend on employment. So what other model could we depend on?
This one showing core inflation plotted against an aggregate corporate profit rate minus a mix of nominal rates. (FRED data link)
Mixed nominal rate = 0.56*Fed rate + 0.44*10-year treasury
Here we have quarterly data since 1958. That is 234 data points! Inflation has stayed within the range filled in with red for all those years.
My prediction…
In this graph, we see the last 8 quarters of data highlighted in red. Corporate profit rates have fallen some. The mixed nominal has actually dropped a bit too, but corp. profits rates have dropped more.
The dark blue arrow marks the predicted upper limit of core inflation according to the pattern set up in the model.
So the model predicts that core inflation will ride along or under this upper limit of around 2.2% as the data points move left on the graph.
Does core inflation show signs of moving along the upper limit?
Here is core inflation over last 8 quarters (monthly data)…
Core inflation rose to around 2.2% and looks to have stabilized at the upper limit in the model above. I predict that core inflation will continue to follow closely to the projected upper limit.
I have a couple of questions for the author.
What do the numbers for “core inflation” mean to my everyday life?
And is there any relationship to the dollar’s role as a “reserve currency”?
Hi Zachary, Core inflation is the more stable inflation that takes out the more price volatile items of food and energy.
I wouldn’t stretch the model to make a connection with the dollar as a reserve currency. The model could apply to other advanced countries too.
EL you stick your neck out and conclude this piece with:
“I predict that core inflation will
continue to follow closely to
the projected upper limit.”
Just so you know, you are very late with this prediction, and you are joining a huge crowd. Who else has the expectation that core inflation will be at or near 2%?? That list includes:
The Federal Reserve
CBO
OMB
Social Security
Virtually all Blue Chip economists
The IMF
When EVERYONE (including EL) says the same thing, then usually it does not happen.
BK, I have a model to explain my prediction. What model do the others use? A prediction has to have a scientific method of testing a model.
Edward:
Not a bad reply to BK. Lets see where this goes. Your data appears to be pointing in a direction. If the model is correct, than it will prove out. It looks like quite a few have picked up on your words. Not bad Edward.
Bill
To Edward Lambert August 25, 2016 12:23 am
Thank you. I believe this establishes once again I don’t understand this issue at all.
The core inflation numbers are used by the governmint to give the illusion that there is no inflation. The real reason why we have no inflation is because we have lost all our jobs and hence consumer demand is low. If the governmint continues to print endless money it can only create more inflation and we could loose our status as the world reserve currency and not be able to print no more. Then you will see some real inflation if that happens… Foe a better view please go see Coalition for Prosperous America.org (8-14-16) article Business Economic Survey from the National Association for Business Economics (NABE) survey. They project 2% inflation for the next 5 years but seem to be pro TPP. They also project a .25 to .50 basis point increase in the Fed Fund rate before years end. 66% objectively the current fiscal policy should be used to enact stronger structural policy reforms to stimulate more robust economic growth in medium to long term…I believe that the passage of the current TPP as it is today will kill any new growth from these plans…If HRC is allowed to flip -flop again on TPP, as she will. It will also kill these very sensitive economic plans. IMHO.
I hate to be picky, Edward, but you stated that all points (or as you put it, “inflation rates” which may be something different) are within your red zone. However, just eyeballing it, it looks like there are four below the range and possibly as many as four above it, one well above it. Granted that is only 8 out of 234, but why did you say that all were within the range when pretty clearly at least some are not?
Hello Barkley, Your point is picky. I could widen the range just a small amount to include those points. But pretty quickly they fall back into the range as it is. The points that are below the real cost boundary resulted from Volcker’s unusual policy to knock back inflation. But even those points did not go far to the left of the real cost boundary.
Seems to me that your model is flawed, in that inflation and the “mixed nominal rate” are not independent variables. If inflation goes up, people will not be so willing to pay so much for 10-year bonds, and yields will go up.
Warren, That is why there is a real cost of money boundary to the left. Corporations do not want a data point to go to the left of that real money boundary which factors out inflation. Having the two boundaries in red allows the model to function well, because the horizontal distance from a data point to the real cost boundary is actually the real net profit.
Edward, that does not change the flaw in the model — but only accentuates it. Since inflation and the “mixed nominal rate” and not independent, and are, in fact, highly correlated, all your model shows is that, as inflation goes up, real corporate profits go to shit.
Warren,
Think about it… is core inflation a specific part of the nominal rates? Let me put it another way… is the nominal rate determined by adding together the core inflation rate and a short term real interest rate? No… The part of the nominal rate that corresponds to the core inflation rate varies upon Fed policy and the inflation target. They are not the same core inflation rate.
Just because they are not THE SAME, does not mean they are independent. The Fed rate is highly dependent on the inflation rate, and the Fed governors say so:
“As with real activity and inflation, the outlook for the future path of the federal funds rate is subject to considerable uncertainty,” [the Board of Governors] added. “This uncertainty arises primarily because each participant’s assessment of the appropriate stance of monetary policy depends importantly on the evolution of real activity and inflation over time. If economic conditions evolve in an unexpected manner, then assessments of the appropriate setting of the federal funds rate would change from that point forward.”
http://www.upi.com/Business_News/2016/07/06/Federal-Reserve-unsure-about-raising-interest-rates-amid-Brexit-US-labor-report/1461467844807/
Furthermore, inflation also drives down the price of 10-year bonds (increasing yields). http://www.crestmontresearch.com/docs/i-rate-10-yr-yield.pdf
The core CPI and the “Mixed Nominal Rate” are not independent variables, and cannot be treated as such.
Hello Warren,
On the y-axis, CPI is determined by corporations. On the x-axis, nominal rates are determined by the Fed and financial markets. Each views prices with different goals and reaction functions. Corporations may be wanting to increase prices, while the Fed wants prices to decrease. Thus nominal rates are used to manipulate inflation in a different way than corporations seek to manipulate inflation.
The level of correlation between core inflation and the inflation projection used to determine nominal rates is sometimes high and sometimes low. The model seeks to capture that dynamic by comparing how corporations view nominal rates, and how they react to nominal rates with their pricing.
It does not matter, Edward. The only thing that matters is that they are not independent variables. As such, your model cannot reliably predict inflation.
Imagine plotting performance by a basketball player (y-axis) against how many minutes the coach decides to keep him in the game (x-axis). Each game is a data point. Performance affects minutes over time, as well, minutes affect performance over time. They are not completely independent variables. So would the plot give you or the coach any useful information?
No, it wouldn’t. Neither does yours.
You will see. Core inflation will follow the model that I posted.
Of course it will. If inflation goes up, the “mixed nominal interest rate” will also go up, and “Corporate Profits/GDP – Mixed Nominal Interest Rate” will go down.
My point is that you cannot use this model as a predictor for inflation, because the variables are not orthogonal.
No… People talking about Fed policy now see a puzzle. Why didn’t inflation go higher with such low nominal rates for so long? Inflaiton should have gone up higher with nominal rates staying low. Then nominal rates only go up when the Fed wants to control inflation. So your description of the model does not wash out. You assume that nominal rates and inflation always travel together. That is not true. The model shows that if nominal rates stay low with high corporate profit rates, inflation will also stay low. The model explains the puzzle confronting the Fed.
“[Inflation] should have gone up higher with nominal rates staying low.”
Uh, no. If the Fed raises interest rates, companies will have to charge more for their products to cover their borrowing costs. Employees will ask for higher wages to get car loans and mortgages. Result — inflation.
With the Fed rates low, there is not pressure to raise prices.
Just do a plot like you have, but make it Mixed Nominal Rate vs. CPI. You will see a pattern, because the two are not orthogonal.
Subtract CPI from the Mixed Nominal Rate, and replot your data.