Why Government Spending is Never the Answer to Crisis

donsutherland1 · Jun 16, 2011

Lakryte said:
Because in order to support government intervention, you have to support one of those 3 principles at least at the time of the intervention. If Keynes did not support them, his argument is logically flawed. But I disagree Keynes did not support any of those principles. Keynes may not have explicitly supported them, but the fact he thought government was necessary to save country from recession means he must have thought that during a recession government acted more efficiently than the free market. How else to you interpret calls for government to save the free market? Isn't the argument that consumers are sitting on money and using it inefficiently by not spending it, therefore government must spend it?

That he didn't support any of the three assumptions you set forth is only inconvenient for your argument. It does not undermine his argument. One can rationalize government intervention for reasons other than the three you listed. Your list is not all-inclusive.

On the first statement, of course. As for the second, using only individual prices as a measure of inflation will only measure the effects of inflation on those individual prices. They will not accurately measure the general price level. This is what I was talking about with housing.

Given all the information that is available, one can construct one's own inflation indices that include consumer prices, producer prices, asset prices, etc. Nothing precludes one from doing so. I happen to believe greater detail is better than one simple number that might or might not fairly represent inflation.

I understand that argument. But if such improvements lead to a rise in price, prices must fall somewhere else.

An illustration: In Year 200X, one paid $50 for a chip (1 GB of RAM). By 200Y, increased efficiencies from scale, learning effects, technological advancement, allowed for one to purchase the same chip (now 2 GB of RAM) for $75. Although one paid 50% more for the chip, there was value added due to the RAM having doubled. In other words, the price per GB of RAM declined from $50 to $37.50. Representative inflation indices should not ignore the reality that one's buying power has increased, not decreased under such a scenario. Your argument suggests that this favorable development be ignored. Were your method utilized, one would report a 50% increase in chip prices despite the reality that the value added had increased more than the price.

You are absolutely correct. But none of that justifies or defends in any way ignoring a rise in price in a certain good because it has a substitute. Inflation effects certain goods more than others, even if the goods are subsitutes. To say because people are buying a substitute because they can no longer afford the good they would have preferred means there is no inflation is bogus.

One cannot ignore consumption patterns if one is trying to measure consumer prices. In the most absurd example, let's say there are only two products A and B (they are substitutes). The price of A rises to such a point that every consumer makes a permanent switch to B. An inflation index that ignores that reality that customers no longer purchase Product A would be irrelevant.

The assumption is that the government knows everything that is happening in the market place at any given time. Individual households spend and save differently. To assume that some bureaucrats can possibly accurately measure the spending habbits of over 300 million people is silly. If they are off even by a a few percentage points, it makes a huge difference in inflation numbers.

The inflation indices do not represent prices the government is imposing on consumers. They reflect prices that are prevailing in the marketplace. Overwhelmingly, those prices result from supply and demand, not government mandate. That government agencies report the prices does not change that reality.

Also, price indices offer a snapshot of what an "average" customer is paying. Needless to say, each consumer is unique. Each has unique consumption patterns. The inflation indices offer a reasonable idea of what is going on in terms of prices.

Premiums should be part of the CPI, especially considering how much money is spent on them. You see, those who publish the CPI tend to remove items that are inflating in price from the basket to keep it looking stable. It really is a joke. If you continually change the ruler, how can you claim to have accurate measurements? Changes in consumer spending on certain items may be a direct result of certain items being more expensive. Say people spend less on candy because it grew too expensive. As a result, the CPI would lower how much weight candy had in its numbers. It has a tendency to remove the items that are inflating the most.

Premiums reflect a combination of underlying costs (part of the inflation indices) and profit objectives of the health insurers. If one is interested in tracking insurance premiums, such data is available. Large amounts of health data from total national expenditures to out-of-pocket expenditures are available. There is no analytical challenge to using such information.

While I won't speak for others, I use multiple indicators to examine price trends (narrow and broad measures, not to mention myriad asset prices). With full knowledge of the limitations of each index and reliance on multiple sources of data, I believe I have a pretty good picture of price trends.

Hence, even as a question was raised not too long ago in one blog as to why QE2 had not resulted in greater inflation, a look at all the data showed that such a question actually missed the mark. QE2 was, among other things, skewing equities prices more than consumer prices, with a clear and accelerating decoupling from national income manifesting itself. And if one understands the various financial linkages and behavior e.g., the incentive to search for yield, that outcome makes reasonable sense. Since that time, the imminent end of QE2, deceleration of U.S. growth, and Greece-related issues have partially reversed the QE2-related distortions.

donsutherland1 · Jun 16, 2011

Lakryte said:
I argue why current CPI understates inflation, and you give me a paper saying why previous CPI overstated inflation and use it to say my arguments support overstating inflation, not understating it.

Goldenboy219's reference to an authoritative examination of the CPI, concluded that the CPI as it was constructed at the time, overstated consumer price inflation. The paper reached a conclusion that differed from your hypothesis. That's the point he was making.

Lakryte · Jun 16, 2011

donsutherland1 said:
That he didn't support any of the three assumptions you set forth is only inconvenient for your argument. It does not undermine his argument. One can rationalize government intervention for reasons other than the three you listed. Your list is not all-inclusive.

Keynes did argue that government was more efficient than the private sector in times of recession. That is why he encouraged spending by the government to boost what he say as a private secor inefficiently keeping resources idle.

Given all the information that is available, one can construct one's own inflation indices that include consumer prices, producer prices, asset prices, etc. Nothing precludes one from doing so. I happen to believe greater detail is better than one simple number that might or might not fairly represent inflation.

I never said anything to the contrary and agree with you on that point completely.

An illustration: In Year 200X, one paid $50 for a chip (1 GB of RAM). By 200Y, increased efficiencies from scale, learning effects, technological advancement, allowed for one to purchase the same chip (now 2 GB of RAM) for $75. Although one paid 50% more for the chip, there was value added due to the RAM having doubled. In other words, the price per GB of RAM declined from $50 to $37.50. Representative inflation indices should not ignore the reality that one's buying power has increased, not decreased under such a scenario. Your argument suggests that this favorable development be ignored. Were your method utilized, one would report a 50% increase in chip prices despite the reality that the value added had increased more than the price.

Inflation is an increase in the price level, not a single price. You are correctly explaining what happens when demand for a product increases due to a better product. The price will rise.
But if the price of the product rises, prices somewhere else will have to fall as long as the money supply is constant. Say you have $10, and bough a 1GB of ram for $4 and then used the $6 to buy 2 bags of chips. New technology increased the value in your mind of the now 2GB of ram, so you pay $6 for it. However, you only have $4 left to buy the chips. Meaning you cannot buy as many chips. In order to clear the market, chip producers will have to lower their prices to clear the market or they will have a surplus of chips that will go to waste. The price of chips will fall to say, $2. But that is not what CPI measures. CPI measures a rise in the general price level, meaning on net balance all goods are increasing in price if there is inflation. The ram is increasing as well as the chips. To accurately measure the price level, the CPI must measure the price of the new technology as it is. If there is no net inflation, the chips will have fallen in price, and the data will reflect it. The price of the 2GB ram cannot increase unless consumers are spending less elsewhere (meaning prices must fall due to drop in demand).

One cannot ignore consumption patterns if one is trying to measure consumer prices. In the most absurd example, let's say there are only two products A and B (they are substitutes). The price of A rises to such a point that every consumer makes a permanent switch to B. An inflation index that ignores that reality that customers no longer purchase Product A would be irrelevant.

They no longer purchase product A because of inflation! The logic is that because A is inflating and B is not, the inflation of A does not matter. That is absurd. If people prefer product A brand but can no longer afford it, they have a reduced standard of living because they must buy their second choice instead.

The inflation indices do not represent prices the government is imposing on consumers.

When on earth did I say that?

Also, price indices offer a snapshot of what an "average" customer is paying. Needless to say, each consumer is unique. Each has unique consumption patterns. The inflation indices offer a reasonable idea of what is going on in terms of prices.

My argument is that the current CPI measure does not, for reasons listed in previous posts and above.

Premiums reflect a combination of underlying costs (part of the inflation indices) and profit objectives of the health insurers. If one is interested in tracking insurance premiums, such data is available. Large amounts of health data from total national expenditures to out-of-pocket expenditures are available. There is no analytical challenge to using such information.

Why they are not included in CPI is still a concern to me regarding CPI inflation data.

While I won't speak for others, I use multiple indicators to examine price trends (narrow and broad measures, not to mention myriad asset prices). With full knowledge of the limitations of each index and reliance on multiple sources of data, I believe I have a pretty good picture of price trends.

I would say that is great. I am glad you don't rely on one measure. But that doesn't refute my argument that current CPI is one of the worst measures.

Hence, even as a question was raised not too long ago in one blog as to why QE2 had not resulted in greater inflation, a look at all the data showed that such a question actually missed the mark. QE2 was, among other things, skewing equities prices more than consumer prices, with a clear and accelerating decoupling from national income manifesting itself. And if one understands the various financial linkages and behavior e.g., the incentive to search for yield, that outcome makes reasonable sense. Since that time, the imminent end of QE2, deceleration of U.S. growth, and Greece-related issues have partially reversed the QE2-related distortions.

I agree. CPI did not correctly display what was going on, and I am trying to explain why it did not and will not if the current method of calculation it uses is continued. Although distortions have not been reversed. Prices are still higher.

Lakryte · Jun 16, 2011

donsutherland1 said:
Goldenboy219's reference to an authoritative examination of the CPI, concluded that the CPI as it was constructed at the time, overstated consumer price inflation. The paper reached a conclusion that differed from your hypothesis. That's the point he was making.

I appreciate you trying to clarify his posts for me, and I know that is what he was trying to do. But he mocked my analysis of current CPI as an analysis that proved the opposite of what I claimed, which was simply not true. His link provides evidence that CPI is not understated, but it does not support his reply that I ended up proving the opposite of what I claimed.

Me: These factors cause inflation to be understated.
Him: No, those factors cause inflation to be overstated. Here is an article that explains how those factors can be used to lower the inflation rate (which in my opinion is understating it. The authors of the study used the factors I talked about to lower the value of CPI numbers. They say it makes inflation more accurate, and I say it makes it understated. But his comment was that those factors were used to overstate inflation, therefore I am wrong. But that was never the case).

themostimproved · Jun 16, 2011

Goldenboy219 said:
In 1996, Professor Michael Boskin reported (to the senate finance committee) a study on the CPI. The findings were, and i quote from the actual paper, "The CPI commission concluded that the change in the consumer price index overstates the change in the cost of living by about 1.1 percentage points a year,....".

The research is considered a "must read" in any quality intermediate macro course. What were the greatest over-estimators? Quality and high/low end substitution biases!

Source

I've heard claims about this, though I didn't know it was so high. It causes interesting changes for the economy. For instance, we've been dramatically understating growth and the actual size of GDP. Also, we've been over paying on social security etc.

Also, it seems that the Fed might be changing their inflation target to say 1% CPI (notice bernanke's recent statements that the Fed isn't going to do much more stimulus, despite being lower then our inflation target), so that would mean we'd be suffering .1% deflation! This means people will get postive returns hoarding currency and we know via Say's law that hoarded currency will put a glut in the rest of the economy, as the private sector can't produce more currency! Yikes!

edit: You've also made me worried about the quality of my intermediate macro course, especially because the professor who taught it specialized in studying inflation. =(

oldreliable67 · Jun 17, 2011

Lakryte said:
CPI did not correctly display what was going on, and I am trying to explain why it did not and will not if the current method of calculation it uses is continued. Although distortions have not been reversed. Prices are still higher.

Just curious. Have you read or studied any of the material on the construction and measurement processes of the CPI? I ask only because thus far, you have posted some lengthy posts but I haven't seen reference to any of the descriptions or analysis of the underlying methodology. The BLS publishes a lot of stuff; you can find links here.

(If you have and I missed it, please correct me!)

Why Government Spending is Never the Answer to Crisis

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