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The Gold Price is Not ‘Too Low’

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Before I start today’s article, let me say that I don’t like to write about gold. The people who are perennially gold bulls are crazy in a way that is unlike the people who are perennial equity bulls (Abby Joseph Cohen) or perennial bond bulls (Hoisington). They will cut you.

That being said, they are also pretty amusing.

To listen to a gold bull, you would think that no matter where gold is priced, it is a safe haven. Despite the copious evidence of history that says gold can go up and down, certain of the gold bulls believe that when “the Big One” hits, gold will be the most prized asset in the world. Of course, there are calmer gold bulls also but they are similarly dismissive of any notion that gold can be expensive.

The argument that gold is valuable simply because it is acceptable as money, and money that is not under control of a central bank, is vacuous. Lots of commodities are not under the control of a central bank. Moreover, like any other asset in the world gold can be expensive when it costs too much of other stuff to acquire it, and it can be cheap when it costs lots less to acquire.

I saw somewhere recently a chart that said “gold may be forming a major bottom,” which I thought was interesting because of some quantitative analysis that we do regularly (indeed, daily) on commodities. Here is one of the charts, approximately, that the analyst used to make this argument:

I guess, for context, I should back up a little bit and show that chart from a longer-term perspective. From this angle, it doesn’t look quite like a “major bottom,” but maybe that’s just me.

So which is it? Is gold cheap, or expensive? Erb and Harvey a few years ago noticed that the starting real price of gold (that is, gold deflated by the price index) turned out to be strikingly predictive of the future real return of holding (physical) gold. This should not be terribly shocking – although it is hard to persuade equity investors today that the price at which they buy stocks may affect their future returns – but it was a pretty amazing chart that they showed. Here is a current version of the chart (source: Enduring Investments LLC):

The vertical line represents the current price of gold (all historical gold prices are adjusted by the CPI relative to today’s CPI and the future 10-year real return calculated to derive this curve). It suggests that the future real return for gold over the next decade should be around -7% per annum. Now, that doesn’t mean the price of gold will fall – the real return could be this bad if gold prices have already adjusted for an inflationary future that now unfolds but leaves the gold price unaffected (since it is already impounded in current prices). Or, some of each.

Actually, that return is somewhat better than if you attempt to fit a curve to the data because the data to the left of the line is steeper than the data to the right of the line. Fitting a curve, you’d see more like -9% per annum. Ouch!

In case you don’t like scatterplots, here is the same data in a rolling-10-year form. In both cases, with this chart and the prior chart, be careful: the data is fit to the entire history, so there is nothing held ‘out of sample.’ In other words, “of course the curve fits, because we took pains to fit it.”

But that’s not necessarily a damning statement. The reason we tried to fit this curve in the first place is because it makes a priori sense that the starting price of an asset is related to its subsequent return. Whether the precise functional form of the relationship will hold in the future is uncertain – in fact, it almost certainly will not hold exactly. But I’m comfortable, looking at this data, in making the more modest statement that the price of gold is more likely to be too high to offer promising future returns than it is too low and likely to provide robust real returns in the future.

Reversing the “Portfolio Balance Channel”

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Today I want to write about something that’s been bothering me a bit recently. It’s about the Fed’s impending decision to start drawing down its balance sheet over some number of years (whether or not we have an announcement about that at tomorrow’s meeting, it seems likely that “balance sheet reduction” is on tap for later this year). Something had been gnawing at me about that, and until now I haven’t been able to put my finger on it.

It concerns the ‘portfolio balance channel.’ This bit of Fed arcana is part of how the central bank explained the importance of the practice of buying trillions in Treasury bonds. Remember that back when the Fed first started doing Large-Scale Asset Purchases (LSAP), they were concerned that a lack of ‘animal spirits’ were causing investors to shy away from taking risk in the aftermath of the credit crisis. Although this is entirely normal, to the FOMC it was something to be corrected – if people and firms aren’t willing to take risk, then it is difficult for the economy to grow.

So, as the Fed explained it, part of the reason that they were buying Treasuries is that by removing enough safe securities from the market, people would be forced to buy riskier securities. When QE1 started, 10-year TIPS were yielding 2.5%, and that’s a pretty reasonable alternative to equities in a high-risk environment. But the Fed’s ministrations eventually pushed TIPS yields (along with other yields, but by focusing on real rates we can abstract from the part of that decline that came from declining inflation expectations rather than the forced decline in real yields) down to zero in 2011, and eventually deeply negative. As expected, despite the risk aversion being experienced by investors they began to move into equities as the “only game in town” – think about how many times you’ve heard people lament they own equities because ‘there’s nothing else worth owning’? The eventual result, of course, was that expected returns to equities began to fall in line with the (manipulated) expected returns to other securities, until we got the current situation where, according to our calculations, TIPS now have a higher expected real return than equities again (but at a much lower level).

What was bothering me, of course, was that shrinking the balance sheet also implies reversing the “portfolio balance channel.” Via QE, the Fed forced investors into stocks because there were fewer Treasury securities outstanding; every time the Fed bought $1 of bonds, some fraction of that went into stocks. The reverse must also be true – for every $1 of bonds the Fed sells, some fraction of that money must come out of stocks.

I’m not the first person to note that reducing the balance sheet should be a negative for equities since it “reduces liquidity.” But I was always uncomfortable with the vagueness of the “liquidity” mechanism…after all, lots of people predicted cataclysm when the Fed “tapered” QE. The reversal of the portfolio balance channel, though, is a real effect. The money to buy the extra bonds that will be on the market – bonds not held by the Fed must be held by someone, after all – will come from somewhere. And some of that “somewhere” will be from equities, some from real estate, some from cash, etc. I don’t know how big an effect it will be, but I know the sign.

Inflation-Linked Bonds: For the Wary, but the “Wise?”

Only a quick article at the moment. This is longer than a tweet-length answer, but didn’t need to be super long.

A friend sent me the link to the following article from the FT:

Will UK inflation-linked bonds be the choice of the wise?

I must confess I don’t know about the answer to that question, although it is true that UK linkers – especially long linkers – are perennially rich thanks to pension fund demand. Below is a chart (source: Enduring Investments) that shows our analytical rich/cheap series for 10-year UK linkers.

But the article also includes a common gripe about inflation-linked bonds that isn’t really fair, and should be addressed. The argument is that inflation-linked bonds don’t really protect against inflation, because changes in real yields are much more impactful to the return than are changes in inflation.

This is true. It is also true that changes in nominal yields are much more impactful to the return of nominal bonds than is the coupon rate or yield on the bond. If you buy a 10-year Treasury yielding, say, 3%, and hold it for two years, you will most likely get a return quite a bit different from 3% because changes in the yield-to-maturity over that period overwhelms the yield of the bond (especially now). You only get 3% if you hold to maturity. (Well, technically you get 3% if you hold for a period equal to the Macaulay duration, but that’s a discussion for another time.)

So it isn’t fair to criticize inflation-linked bonds for not being an inflation hedge over every time period. As with nominal bonds, they are a perfect inflation hedge if held to the proper horizon, and a less-than-perfect hedge over different time periods.

However, you shouldn’t be trying to hedge inflation over the next week or month. You should be trying to hedge inflation over the long term. Accordingly, the fact that returns vary due to changes in real yields is not a damning fact about linkers. Unless, of course, you’re a highly levered participant.

Categories: Bond Market, Quick One, Theory, TIPS, UK

The Internet Has Not Killed, and Will Not Kill, Inflation

June 21, 2017 3 comments

Every few years or so, this story goes around to great acclaim: inflation is dead, killed by the internet. Recently, we have been hearing this story again, quite loudly. The purchase of Whole Foods by Amazon helped bring commentaries like these to the fore:

Credit Suisse’s Varnholt Says Internet Killed Inflation” (Bloomberg)

Low U.S. Inflation? It’s Your Phone: BlackRock Bond Manager” (New York Times)

Amazon Deal for Whole Foods Casts Doubt on Fed’s 2% Inflation Goal” (Barron’s)

And the list goes on and on. These are some of the more-reputable outlets, and they simply misunderstand the whole phenomenon. This isn’t unusual; almost no one really understands inflation, partly because almost no one these days actually studies something that most people presume isn’t worth understanding. (But pardon my ranting digression.)

The internet has not killed, and will not kill, inflation.

In the late 1990s, the internet was having a much greater relative impact. We went from having essentially zero internet in 1995, to a vast array of businesses in 1999 – most of whom were busy transferring money from capital markets to consumers, by raising equity investments which were then use to subsidize money-losing businesses (see especially: Amazon). And inflation? Core CPI in 1999 was 1.9% (Median CPI was 2.03%).

“But there’s more internet now than there was then!” runs the natural objection. Yes, and the internet was dramatically more impactful in 2001 than it was in 1999. Indeed, as the penetration of the internet economy exploded further despite the recession of 2000-2001, core inflation rose to 2.8% (Median CPI topped out at 3.33%) by late 2001.

There is always more innovation happening, whether it’s the 1940s or the 2010s. Innovation is a relatively steady process on the economy as a whole, but very dramatic on parts of the economy – and we tend to fixate on these parts. But there is no evidence that Uber is any more transformative now than Amazon was in the late 1990s. No evidence that Amazon now is any more transformative than just-in-time manufacturing was in the 1980s (in the US). And so on.

“But the internet and mobile technology pervades more of society!” Really? More of society than the J-I-T manufacturing innovation? More of society than airlines and telephones, both of which were de-regulated/de-monopolized in the 1980s? More of society than personal computers did in the 1990s? We all like to think we are living in unique times full of wonder and groundbreaking innovation. But here’s the thing: we always are.

“But Amazon bought Whole Foods and disrupted the whole food industry! How can you be more pervasive than food?” It remains to be seen whether Amazon is able to do what Webvan and FreshDirect and other food delivery services have been unable to do, and that is to remake the entire delivery chain for food at home. But let’s suppose this is true. Food at home is only 7.9% of the consumption basket, which is arguably less than the part of society that Amazon has already reorganized. Moreover, it’s a highly competitive part of society, with margins that are already pretty thin. How much fat is there to be cut out by Amazon’s efficiency? Some, presumably. But after Amazon makes some kind of profit on this improvement, how much of a decline in food prices could we see? Five percent, over five years? 10%? If Amazon’s “internetification” of the food-at-home industry resulted in a 10% decline in prices of everything we buy at the grocery store, over five years, that 2% per year would knock a whopping 0.16% off of headline inflation. Be still, my heart.

“In any event, this signals that competition is getting ever-more-aggressive.” No doubt, though it is ever so. But here is the big confusion that goes beyond all of the objections I’ve previously enumerated: microeconomic effects cause changes in relative prices; macroeconomics is responsible for changes in the overall price level. Competitive pressures in grocery may keep food prices down 10% relative to price increases in the rest of the economy. But suppose the money supply doubles, and all prices rise 100%, but food prices only rise 90%. Then you have your 10% relative deflation but prices overall still rose by a lot. If the governments of the world flood economies with money, no amount of competition will keep prices from rising. This is why there wasn’t deflation in 2010, despite a massive economic contraction in the global financial crisis and concomitant cutthroat competition for scarce customers in many industries.

So inflation isn’t dead, and neither is this myth. It will come back again in a few years – I am sure of it.

The Bias in Investor Perceptions

June 1, 2017 4 comments

We can do the math. We can, until we are blue in the face, explain to investors why 10% returns in the equity market…even 7% returns…are unlikely going forward. We can show the picture below, sourced from data from Robert J Shiller, illustrating that high starting cyclically-adjusted PE ratios are associated with low future returns (the current level of the CAPE is about 29.5), and admonish that higher levels of the CAPE have been seen on only a few occasions that we all agree ex-post were bubbles.

We can do all this, and yet investors still anticipate that 10-20% returns will be delivered by equities going forward. The pessimistic ones think that only 5-10% is what we will see, ‘in line with historical returns’ that are as high as that of course only because our measurement ends at the current high levels. None of our arguments are new, and research illustrating that investors in the main do not get out just in time to avoid the bear market is hopelessly general because each individual enjoys his or her personal fable: “yeah, but I’m not that guy.”

They can be forgiven, perhaps, their poor memories because, after all, the bad events have been few and far between (at least, the bad events in terms of market returns) for a long time. The chart below shows the rolling 52-week returns of the S&P 500, before dividends, since 1979.

The two financial crises in the 2000s stand out for their deeply negative returns, and contrast with the more-frequent, but shallower, bear markets of the 1980s (of course, there weren’t any bear markets in the 1990s!). The compounded nominal price return since the end of 1978 until the end of last week was 8.76%.

But that’s not how people remember returns. Normal people do not take the ending point, divide by the starting point, and raise to the power of 1/(number of years). Perception is influenced by recency. Over the past five years, if you had asked each week “what has the return of the stock market been over the last year?” the answers would have averaged 12.0%. That’s recency. Perception also weights returns by frequency of observation – and over the 38 years covered by this chart, the average rolling 12-month return has been 9.9%.

So you can understand why individual investors resist when we tell them “the long run return of stocks has been about 7%” or admonish them to be careful about current high prices. In their minds, “stocks have been rising about 10-12% per year” for nearly four decades.

Selective memory also plays a part. When we tell stories about why these events occurred, and the story doesn’t include “we started from very high prices,” we excuse them as exceptions. The bear market in the early 2000s was “the popping of the Internet bubble,” and the one in the late 2000s was “the global financial crisis caused by greedy banks.” So the mind tends to dismiss these exceptions, or weight them less. This is where the “but I will get out next time” fantasy comes in – it justifies this mental calculation. But of course, if we eliminate the “exceptions” when stocks went down, the annual returns are even more remarkable. Since 1979, the rolling 12-month return conditioned on it being positive averaged 16.6%.

These are all irrational, but they are part of perception. From a practitioner’s standpoint, these are inconvenient and the industry has worked for a long time to try and educate investors away from these perceptions since otherwise clients only want to hold stocks. But we can’t change how people think, and how they perceive market returns.

This problem has gotten worse since the early 1990s, because of the accessibility of information about market returns. The Financial News Network was launched in 1981, but it wasn’t until CNBC’s launch in 1989, combined with Chairman Greenspan’s decision to open the Fed’s kimono a few years later, that it became very easy to “check the market.” And, since perception of returns is weighted by the number of observations, more frequent observations of positive numbers has increased the expectations of investors when it comes to stock market returns. Some of the lower-quality advisors actually make the problem worse, by calling clients more often when markets are up than when they are down.

I think education is nice, and we as practitioners should of course try to convey to clients proper expectations for returns. But we can’t beat these cognitive errors; instead, what we should be trying to do is to avoid the focus on recent returns and instead present the client with their progress towards a very long-term goal (see illustration below, which is from something we’re designing), such as a particular sort of goal in retirement (“I’d like to have enough to take two major trips every year.”)

This unfortunately can lead to other games, which I will talk about next week, but it also allows us to manage wealth in a way that beats the outcomes offered by Modern Portfolio Theory’s focus on near-term mean-variance optimization. Now, if only we can persuade clients to do it!

Categories: Investing, Stock Market, Theory

Profits and Health Care: A Beneficial Connection

March 17, 2017 4 comments

I usually try to avoid political commentary in this space, because it has become so personal to so many people. If I point out that a particular program of the “left” is smart, or cleverly put together, then half of my readership is annoyed; if I point out the same about the right, then half of my readership is angry. It doesn’t really make sense to waste article space except on those occasions when a policy has a clear effect on inflation over time, such as when the structure of the ACA made it clear that it would put upward pressure on inflation (as I pointed out in 2013) or in response to someone else’s flawed analysis of a policy, as I did last year when I tackled the San Francisco Fed for their weak argument about how the ACA would hold down inflation because the government would demand lower prices. Actually, there is no policy I have written about more than the ACA over the years – but again, this was economic commentary and not political commentary.

This article will be short, but different in that I am writing it to express frustration with the absolute lack of intellectual clarity on the part of the Republicans in making a particular argument that immediately impacts the debate over health care but also extends far into other policies. And, because the argument is simple, direct, and has tremendous empirical support, I couldn’t restrain myself. I expect this article will not be picked up and syndicated in its usual channels since it isn’t directly about economics or markets, but it needed to be said.

I’ve been stewing about this topic since Tuesday (March 14th), when I happened to catch part of the daily White House press briefing. Press Secretary Sean Spicer was asked a question about the President’s health care proposal, and tap danced away from the question:

Q    Thanks, Sean.  You mentioned the call with the CEO of Anthem Health.  Can you tell me what this proposal of the President means for health insurance companies?  Will their profits go up or down under the President’s proposal?

SPICER:  Well, I don’t think that’s been the focus of the President’s proposal.  It’s not about them, it’s about patients.  But I think what it means for them is that they finally get to create more choice and more plans and allow people to choose a plan that fits them.  Right now, they don’t have that choice.  And, frankly, in more and more markets, companies like Anthem, UnitedHealth, Signa are pulling out — Aetna — because they don’t have the choice and because of the government mandate.  I think what we want to do is allow competition and choice to exist so that they can offer more options for the American people.

Q    But will those companies make more money under the President’s plan or less?

SPICER:  I don’t know the answer to that.  That’s not been the focus of what we’re doing now.  And at the end of the day, right now they’re pulling out of market after market, leaving the American people with fewer and fewer choices.  So right now it’s not a question of — from the last I checked, I think many of them were doing pretty well, but it’s the American people and its patients that are losing under the current system.  So I think that there’s a way you can do a little of both.

Spicer’s response was the usual drivel that the Republicans have adopted when they run in fear from any question that includes the word “profits.” To summarize, the question was basically, “you’re doing this to throw a sop to fat-cat insurance companies, aren’t you?” and the answer was “we don’t think about that. No idea. Profits? Who said anything about profits? It’s about patients and choice. And, if anyone gets more profits, it wasn’t on purpose and we didn’t have anything to do with it.”

But this was actually a softball question, and the answer ought to have been something like this:

Q    But will those companies make more money under the President’s plan or less?

BIZARRO SPICER: Well, I hope so. After all, the insurance companies want every person in America to have health care – which is the same thing that we want – because the more people they sell their product to, the more money they can make. The insurance companies want to sell insurance to every person in the U.S. The insurance companies also want costs to be lower, and constantly strive to lower the cost of care, because the lower that costs are, the more profit they can make in the short run. But they don’t want lower costs at the expense of health – clearly, the best outcome for their profits is that most people covered by insurance are healthy and so don’t require the insurance they’ve paid for. So, if we just get out of the way and let companies strive for better profits, we are likely to get more coverage, lower costs, and a healthier population, and that is the goal of the President’s plan.

The reason we don’t already have these things is that laws we have previously passed don’t allow insurance companies to offer certain plans, to certain people, which both sides want but which politicians think are “unfair” for one reason or another. Trying to create a certain preconceived Utopian outcome while limiting profits of insurance companies is what caused this mess in the first place.

If you want to beautify gardens in this city, does it make sense to limit the amount of money that gardeners can make? If you did, you would find fewer gardens got tended, and gardeners would not strive to make improvements that they didn’t get paid for. We can see this clearly with gardeners. Why is it so hard to understand with the companies that tend to the nation’s health? Next question.

For some reason, Republicans think that saying “profits are good” is the same thing as saying “greed is good” and leads to caricatures of conservatives as cigar-smoking industrialists. But while at some level it is the desire for a better material outcome – which I suppose is greed, but aren’t there degrees of greed? – that drives the desire for profit, we cannot dismiss the power of self-interest as a motive force that has the effect of improving societal outcomes. “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest,” after all.

Of course, Republicans must also remember that profit without competition is a different animal. If an insurance company creates an innovation that lowers medical care costs, but does not face competitive pressure, then the benefit of the innovation accrues to the company alone. There is no pressure in such circumstances for the company to lower the price to the customer. But consider what happened to air fares after the deregulation of 1978, or to the cost of telephone service when the AT&T monopoly was broken up in 1984, as competition was allowed and even encouraged. Competition, and the more brutal the better, is what causes companies to strive for an edge through innovation, and it’s also what causes the benefit of that edge to eventually be accrued by the end customer. The government didn’t invent cell phones. Motorola did, in order to try and gain an edge against AT&T,[1] but until the telephone monopoly was broken up there were no commercial versions of the cell phone. The first cell phones cost $10,000 in 1983, about $25,000 in today’s dollars, but now they are ubiquitous and cost about 2% as much in real terms. But this didn’t happen because of a government program to drive down the cost of cell phones. It was the profit motive, combined with competition. All that government did was create the conditions that allowed innovation and competition to happen. And wouldn’t we like health care to be as ubiquitous and cheap as cell phones are?

This is not a hard thing to get right. It isn’t hard for people to understand. But for some reason, it seems incredibly hard for politicians to believe.

Note that nothing I have written here should be construed as an opinion about the President’s health care plan, which I have not read. My remarks are only meant to reflect on the utter inability of Republicans to properly convey the reasons that a different approach – one where the government’s involvement is lessened, rather than increased – would make more sense.

[1] The first cell phone call was made by the inventor, Martin Cooper at Motorola, who called his competition with it: the head of the cellular program at AT&T. According to him, he said “Joel, I’m calling you from a cellular phone, a real cellular phone, a handheld, portable, real cellular phone” and he said it got really quiet on the other end of the line.

Good Models and Bad Models

I have recently begun to spend a fair amount of time explaining the difference between a “good model” and a “bad model;” it seemed to me that this was a reasonable topic to put on the blog.

The difference between a good model and a bad model isn’t as obvious as it seems. Many people think that a “good model” is one that makes correct predictions, and a “bad model” is one that makes bad predictions. But that is not the case, and understanding why it isn’t the case is important for economists and econometricians. Frankly, I suspect that many economists can’t articulate the difference between a good model and a bad model…and that’s why we have so many bad models floating around.

The definition is simple. A good model is one which makes good predictions if high-quality inputs are given to the model; a bad model is one in which even the correct inputs doesn’t result in good predictions. At the limit, a model that produces predictions that are insensitive to the quality of the inputs – that is, whose predictions are just as accurate no matter what the inputs are – is pure superstition.

For example, a model of the weather that depends on casting chicken bones and rat entrails is a pretty bad model since the arrangement of such articles is not likely to bear upon the likelihood of rain. On the other hand, a model used to forecast the price of oil in five years as a function of the supply and demand of oil in five years is probably an excellent model, even though it isn’t likely to be accurate because those are difficult inputs to know. One feature of a good model, then, is that the forecaster’s attention should shift to the forecasting of the inputs.

This distinction is relevant to the current state of practical economics because of the enormous difference in the quality of “Keynesian” models (such as the expectations-augmented Phillips curve approach) and of monetarist models. The simplest such monetarist model is shown below. It relates the GDP-adjusted quantity of money to the level of prices.

This chart does not incorporate changes in money velocity (which show up as deviations between the two lines), and yet you can see the quality of the model: if you had known in 1948 the size of the economy in 2008, and the quantity of M2 money there would be in 2008, then you would have had a very accurate prediction of the cumulative rate of inflation over that 60-year period. We can improve further on this model by noting that velocity is not random, but rather is causally related to interest rates. And so we can state the following: if we had known in 2007 that the Fed was going to vastly expand its balance sheet, causing money supply to grow at nearly a 10% rate y/y in mid-2009, but at the same time 5-year interest rates would be forced from 5% to 1.2% in late 2010, then we would have forecast inflation to decline sharply over that period. The chart below shows a forecast of the GDP deflator, based on a simple model of money velocity that was calibrated on 1977-1997 (so that this is all out-of-sample).

That’s a good model. Now, even solid monetarists didn’t forecast that inflation would fall as far as it did – but that’s not a failure of the model but a failure of imagination. In 2007, no one suspected that 5-year interest rates would be scraping 1% before long!

Contrariwise, the E-A-Phillips Curve model has a truly disastrous forecasting history. I wrote an article in 2012 in which I highlighted Goldman Sachs’ massive miss from such a model, and their attempts to resuscitate it. In that article, I quoted these ivory tower economists as saying:

“Economic principles suggest that core inflation is driven by two main factors. First, actual inflation depends on inflation expectations, which might have both a forward-looking and a backward-looking component. Second, inflation depends on the extent of slack (or spare capacity) in the economy. This is most intuitive in the labor market: high unemployment means that many workers are looking for jobs, which in turn tends to weigh on wages and prices. This relationship between inflation, expectations of inflation and slack is called the “Phillips curve.”

You may recognize these two “main factors” as being the two that were thoroughly debunked by the five economists earlier this month, but the article I wrote is worth re-reading because it describes how the economists re-calibrated. Note that the economists were not changing the model inputs, or saying that the forecasted inputs were wrong. The problem was that even with the right inputs, they got the wrong output…and that meant in their minds that the model should be recalibrated.

But that’s the wrong conclusion. It isn’t that a good model gave bad projections; in this case the model is a bad model. Even having the actual data – knowing that the economy had massive slack and there had been sharp declines in inflation expectations – the model completely missed the upturn in inflation that actually happened because that outcome was inconsistent with the model.

It is probably unfair of me to continue to beat on this topic, because the question has been settled. However, I suspect that many economists will continue to resist the conclusion, and will continue to rely on bad, and indeed discredited, models. And that takes the “bad model” issue one step deeper. If the production of bad predictions even given good inputs means the model is bad, then perhaps relying on bad models when better ones are available means the economist is bad?

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