Festivus 2021 – I Got a Lot of Problems with You People

It is almost December 23rd and that means that Festivus is nearly upon us. (Actually, Festivus is floating holiday that can be observed whenever one chooses to.) It is traditional on Festivus to air one's grievances. And this Festivus, I got a lot of problems with you people. My problems with you mainly concern inflation – the cause of it rather than the description of it. Related to this is the incorrect, in my opinion, assumption made by the media and many economists that increased government spending causes higher inflation. In addition I have a problem with the media reporting that the headline number of an economic release was higher/lower than economists expected.

The faster rise in consumer prices began to be noticed in the spring of this year. Rather than discussing the cause, economists and the media tended to describe the faster increases in various consumer price indices. For example, the rate of consumer price inflation was increasing because used car prices were racing ahead. And if were not increases in used car prices one month resulting in an increase in a consumer price index, it might be restaurant meals the next month. This reminds me of President Calvin Coolidge's "analysis" of unemployment, to wit, "[w]hen more and more people are thrown out of work, unemployment results." I suspect Cal wished he had been silent on this one. But this was the initial "analysis" of rising consumer price inflation this past spring. Inflation went up because the price of this or that item in a price index went up. This is merely a description of an increase in price inflation.

Then soon we had new definitions of "core" inflation such as all items excluding the prices of food, energy and used cars. In other words, if we exclude items with rising prices, higher inflation rates vanish. In December 2021 energy prices have fallen, which likely will moderate the rate of increase in consumer price indices. I wonder if a new "core" definition will be trotted out, this one including energy prices but excluding shelter costs.

In my opinion, the concept of "core" inflation has done a lot to discredit economists. Fed Chairman Arthur Burns is responsible for its inception. In 1973, the global economy suffered two negative supply shocks – the failure of anchovies to show up off the coast of Peru, which indirectly caused a sharp increase in animal protein prices, and OPEC's decision to cut oil production. Chairman Burns asserted that the increases in food and energy prices were not caused by his management of monetary policy. He was right about food prices; not so much about energy prices. In August 1971 the Nixon administration discarded the 1944 Bretton Woods international monetary arrangement whereby the US dollar was fixed to gold at a price of $35 an ounce and other foreign currencies were tied to the US dollar at fixed rates. So, an era of floating exchange rates was entered into after August 1971. Leading up to and after the 1971 Nixon "shock", Burns oversaw an explosion in the growth of thin-air credit (the blue bars in Chart 1). The foreign exchange value of the US dollar collapsed after the Nixon "shock", as illustrated in Chart 1 by the decline in the US dollar vs. the German D-mark (the red line). What does this have to do with the price of oil? OPEC was receiving US dollars for its sales of oil, US dollars that were declining in terms of purchasing power. In an attempt to restore the purchasing power for the US dollars it was receiving for its oil sales, OPEC raised the US dollar price of their oil by cutting production. And, oh yes, there was the matter of a war between Israel on one side, Egypt and Syria on the other side in October 1973, after which OPEC imposed an embargo on oil sales to countries viewed as Israeli allies. Whether the Yom Kippur War was the real reason for the OPEC embargo or just convenient cover for the action could be debated, as I am sure it will be in comments to this epistle. Why not? ‘Tis the season to air one's grievances.

Well, back to Burns and core inflation. Because Burns believed that the 1973 price increases in food and energy had nothing to do with monetary policy, he directed the Federal Board staff to come up with a CPI measure that excluded food and energy prices. The price increases in both food and energy were manifestations of negative supply shocks. The physical supplies of things – fishmeal and oil – that were used to produce other things had contracted. This meant that growth in US real production of goods and services was constrained. If nominal aggregate income had remained constant with the decline in real aggregate supply, after using more income to purchase food and energy, households and businesses would have less income left over to purchase other goods and services. With a lag, the prices of other goods and services would fall, offsetting the rise in food and energy prices. Thus, again with a lag, the all-items CPI would not rise (or its rate of change would not increase). But if growth in nominal aggregate income were stimulated by an expansive monetary policy, then, with a lag, price increases would occur in a large number of items other than food and energy prices. This is exactly what happened after the negative food and energy supply shocks of 1973. As shown in Chart 2, first growth in the all-items CPI increased as a result of the negative food and energy supply shocks (the blue bars). Then with a lag, growth in the CPI, excluding food and energy prices, began to increase (the red line). Notice that growth in thin-air credit (the green line) remained elevated through 1974, stoking the growth in aggregate income and inflation, including or excluding food and energy prices. So, increases in the price of a given item because of a negative supply shock can morph into price increases of a broader number of items if a supply shock is accompanied by rapid growth in thin-air credit, i.e., an accommodative monetary policy. With negative supply shocks almost immediately come increases in the unemployment rate. It would take a courageous and enlightened central banker to not react to this with a more accommodative monetary policy. Perhaps the pre-euro Bundesbank would have had the courage and enlightenment, but not the Fed neither in 1973 nor in 2020. The current onset of the Omicron Covid-19 wave will likely result in an increase in unemployment insurance claims. I suspect that this will delay hikes in the federal funds rate penciled in by the Powell Fed.

In the spring of 2021, when the year-over-year percent change in the CPI for all items breached the 4% ceiling, the cognoscenti told us not to worry because it was due to "base" effects. The CPI had actually fallen in March, April and May 2020. So, the spring of 2021 year-over-year percent changes in the CPI were just due to the lower spring of 2020 base. But in April and May of 2021, the month-to-month annualized percent changes in the CPI were 4.2% and 5.0%, respectively. No base effect here. Rather, these large month-to-month changes were transitory until they continued for the next six months (see Chart 3)!

Covid-19 delivered a global negative supply shock in early 2020. Many people could not work because either they were ill, their employers shutdown operations or they had to stay home with their children due to the closure of daycare facilities and schools. With fewer people working, less product can be produced. The US government did the humane thing by making transfer payments to households and businesses to cushion their loss of income during this pandemic. We can argue about the waste and corruption that went along with these transfer payments, but something had to be done quickly to prevent severe hardships. But were these really transfer payments in the sense that income was transferred from some households to other households? If so, some households and businesses would have had to cut back on their current spending so that others would not have had to. Net, net, there would not have been an increase in the growth in nominal aggregate demand, just a redistribution of spending. But this is not what happened. Rather the Fed and the banking system created credit out of thin-air to fund a large portion of the government direct payments to households and businesses (see my commentary "Helicopter Money + Negative Supply Shock = Higher Inflation", October 25, 2021). This meant that no entity had to curtail their spending so that others could maintain theirs. The data in Chart 4 reflect this. What I have done is calculate the 2012 to 2021 trend of US nominal aggregate demand (nominal Gross Domestic Purchases) and the trend line for the real supply of goods and services available to US entities (real Gross Domestic Product minus real exports plus real imports). The blue line in Chart 4 represents quarterly observations of actual levels nominal aggregate demand as a percent of their trend levels. Similarly, the red line represents actual levels of the real supply of domestically-available goods and services as a percent of their trend levels. The green bars representsthe quarter-to-quarter annualized percent change in the implicit price deflator for Gross Domestic Purchases. As of the third quarter of 2021, nominal domestic demand for goods and services was 4.4 percentage points above its 2012 – 2021 trend level. But the real supply of domestically-available goods and services was only 1.5 percentage points above its trend level. And what happens when demand exceeds supply? The green bars in Chart 4, i.e., the rate of inflation increases.

Monetary policy affects aggregate nominal demand, not real aggregate supply. The rapid growth in thin-air credit (i.e., the sum of the monetary base plus depository institution credit) engineered by the Fed in reaction to Covid-19 in 2020 has caused, with a lag of about four quarters, commensurate rapid growth in nominal aggregate demand (i.e., nominal Gross Domestic Purchases). This is shown in Chart 5.

It seems as though both the media and business economists are Econ 101 Keynesians in that they believe that, all else the same, changes in government spending cause changes in nominal and real aggregate demand in the same direction. For example, immediately after the apparent "death" of the Democrats' $1.75 trillion Build Back Better fiscal program had been announced on Sunday, December 19, by Senator Manchin, Moody's Analytics revised down its 2022 real GDP forecast. When the federal government increases its spending, where does it get the money to pay for it? Three ways and only one leads to an increase in aggregate demand. The most common way the federal government funds its increased spending in recent decades is to issue bonds to the public. And where does the public get the funds to purchase these new bonds? Either by cutting back on current spending (i.e., increasing saving) or cutting back on lending to others than the federal government. In both cases, someone cuts back on current spending by the amount the federal government increases spending. Net, net, there is no increase in spending. Oh, wait a minute, what if foreign entities purchase the new federal government debt? They cut back on their purchases of US-produced goods and services in order to buy the new debt. Another way the federal government can fund its increased spending is by raising taxes. Taxpayers must either cut back on their current spending or their lending to others to pay the higher taxes. Again, there is no net increase in aggregate spending emanating from increased federal government spending. But what if the Fed and the banking system buy an amount of Treasury securities equal to the increase in federal government spending? Where do the Fed and the banking system get funds to purchase Treasury securities? By creating funds figuratively out of thin air. You see, the Fed and the banking system are legal "counterfeiters". If they fund the federal government's increased spending, then the government's spending goes up and no one else's spending goes down. Therefore, there will be a net increase in aggregate spending, all else the same. Senator Manchin might have legitimate reasons to oppose the increased government spending that is associated with the Build Back Better program, but fear of it causing higher aggregate demand and higher inflation is not one of them unless the funding of it is by credit created out of thin air. The Fed is not required to allow thin-air credit to increase to fund increased government spending. Milton Friedman and Robert Laurent, may you both rest in peace, I wish you around to explain this better than I am able to.

I'm almost finished airing my 2021 grievances. But I get agitated when the media say that some headline figure in an economic report is higher or lower than what economists expected. Who are these anonymous economists? How often do their forecasts of these headline figures come close to the bullseye? Why would any rational person expect some of these forecasts to be close to the bullseye? For example, how do you accurately forecast weekly seasonally-adjusted new unemployment insurance claims? The media collect forecasts from various economists and then report the median of the forecast figure. Every economist's "vote" gets the same weight in the median calculation regardless of her previous forecasting record. Rather than reporting a median forecast, publish each economist's forecast with names attached. If one or more names consistently come up with accurate forecasts, then we could pay attention to them. Of course, if they really were good forecasters, why would they reveal their forecasts to the public? Couldn't they or their employers make higher trading profits on accurate forecasts not shared with the public? Ok, so I am a self-loathing economist (see "Curb Your Enthusiasm", season 2, episode 3).

My final grievance of 2021 has to do with drivers who don't turn on their vehicles' lights when it is raining. Hell, even Florida used to have a regulation that your lights were on when your windshield wipers were on. I know you can't see any better with your headlights on when it is raining during the daytime. But if your taillights were on, I could make out the location of the rear end of your vehicle. Of course in this day and age, ain't no guvmint gonna tell me to turn on my lights!

I bet you have grievances you would like to air after reading this rant, assuming anyone does read it. One of them might be why does Kasriel italicize so many words?

Well, I have brought the aluminum Festivus pole up from the basement. It is made of aluminum because of its high strength-to-weight ratio. And the clock in the bag is hung on the wall. Why is clock in a bag hung on a wall? No one really knows. It's just an ancient Festivus tradition. So, it is time to gather around the pole, lift a glass of single-malt Scotch, (Lagavulin, if you are thinking of a present for me) and join in the singing of "O Festivus". Remember, Festivus is not over until you pin me.

O' Festivus Lyrics by Katy Kasriel
To the melody of O' Tannenbaum

O' Festivus, O' Festivus,
This one's for all the rest of us.
The worst of us, the best of us,
The shabby and well-dressed of us.
We gather ‘round the ‘luminum pole,
Air grievances that bare the soul.
No slights too small to be expressed,
It's good to get things off our chest.
It's time now for the wrestling tests,
Feel free to pin both kin and guests,
O'Festivus, O' Festivus,
The holiday for the rest of us.

And a contentious Festivus 2021 to all.

Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.