Well, at least the quality improvements of the iPad2 weren’t mentioned…

This paper by the San Francisco Fed’s Bharat Trehan, who, like most government economists has clearly drunk the Federal Reserve kool-aid, argues that Americans’ inflation expectations are unduly influenced by the rising cost of food (which they must buy in order to survive) and energy (which they must consume in order to travel back and forth to work) rather than the many low priced items we import from Asia.

This Economic Letter argues that the jump in household inflation expectations is a reaction to the recent energy and food price shocks, following a pattern observed after the oil and commodity price shocks in 2008. The data reveal that households are unusually sensitive to changes in these prices and tend to respond by revising their inflation expectations by more than historical relationships warrant. Since commodity price shocks have occurred relatively often in recent years, this excessive sensitivity has meant that household inflation expectations have performed quite badly as forecasts of future inflation.

Then again, maybe inflation, as calculated by government economists, does a poor job of reflecting what people actually spend money on, particularly at low income levels where food and energy make up a much larger share of their expenditures.

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[I've long railed against how government economists calculate the inflation rate and it must have hit home when we had to replace a television set a couple of years ago after not having purchased one in quite a few years and then going to look at the Labor Department's data on the recent history of TV prices. When combined with the fact that nearly all electronics goods, apparel, shoes, and many other consumer items are imported from low wage countries such as China, it is little wonder why inflation has been so low over the years. Published back on April 10th, 2008, this provides one case study of how the "official" inflation numbers are out of whack - if only they could find a way to hedonically adjust gasoline prices, it would be all over for inflation in the U.S.]

ooo

Anyone wanting to better understand one of the primary reasons why we are in such an economic mess these days need look no further than the history of television prices over the last half-decade or more.

Actually there are two versions of TV prices – the real world “in”-flation experience and the government’s “de”-flation version.

This point was made clear yesterday when we purchased a replacement for our 2002-era 32″ CRT model – a replacement that not only proved to be more costly but, as an added bonus, less functional.

A quick recap is in order.

In one of the more egregious examples of quality adjustments at the Bureau of Labor Statistics (also see automobiles, computers, and, well, just about anything that is imported) television prices have been falling for years – not necessarily at Best Buy, but certainly at the BLS.

As can be calculated from the BLS data in the chart below, that $500 TV from 2002 – the one that is now awaiting a one-way trip to the recycling center – should have been replaced with one of equal “value” today costing only $178.

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The Federal Reserve seems to have those they think matter most – consumers responding to surveys and the bond market – convinced that inflation over the long-term is not going to be a problem, one of the key points made by Fed Chief Ben Bernanke in Wednesday’s press conference. This report in the Wall Street Journal today takes up that issue and presents the key measures that economists at the central bank watch closely.

Long-term inflation-expectations, from consumers and from the bond market, remain subdued and are little changed from a year ago. They point to inflation that isn’t far above the average of the past decade, when inflation was historically low.

One rough gauge of future inflation expectations is the gap between yields on plain-vanilla Treasury bonds and Treasury inflation-protected securities of the same maturity.
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One favorite such measure is the “five-year, five-year-forward” break-even rate, which measures inflation expectations starting five years from now and running five years from that date.

The Federal Reserve Bank of New York’s five year, five-year forward break-even rate estimate, widely acknowledged as the gold standard of such rates, was recently 3.02%, slightly below its level in November, when the Fed announced its $600 billion quantitative easing program, or QE2.
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A measure of long-term consumer inflation expectations echoes the message of the TIPS market. According to a monthly survey by the University of Michigan, consumers expect CPI inflation of just 2.9% in the next five years, according to a preliminary survey in April.

That long-term calm is in stark contrast to consumers’ short-term view, which sees inflation jumping 4.6% in the next year, the highest since August 2008, when oil prices were just off their highs near $150 a barrel.

Let’s hope that the Bernanke Fed is better at predicting the future path of consumer prices than they were at seeing into the future a few years ago and forecasting where home price might go and how credit markets and the banking system would hold up.