Inflation Data Not Useful Without Food, Fuel Prices

How pathetic has the financial world become when we await with tense anticipation the latest figures on consumer price inflation from the Reserve Bank of Australia? Of course the figures will determine if the RBA raises rates. This affects the local currency and the appetite for local assets. But does the RBA even accurately calculate inflation?

The Banks uses what it calls a "trimmed mean." In a research paper published on its site, it explains that, The trimmed mean will be affected even by elements which are 'excluded' because their magnitude will determine the location of the centre of the ordered distribution, but will be less affected by outliers than published inflation. In theory, the weighted median is the measure least likely to be affected by outlying price movements."

What good is a theoretical measure of inflation that strips out those things (like food and energy) that are actually rising in price? Statisticians, believing that the economy ideally exists in a state of equilibrium, like to eliminate 'outliers,' events that limit the usefulness of their inflation models.

Models, though, are only useful if they have both explanatory and predictive power. Inflation models which diminish the importance of regular (but unpredictable) spikes in prices are not useful models. It's not the data the RBA should be getting rid of, it's the model.

But that would be admitting that the Central Bank is ignorant of what really causes inflation: an increase in money supply. True, news and events- like a drought or a cyclone-can cause particular goods or services to rise in price as they become less available. But inflation is a monetary phenomenon. And like everything else, it shows up first in the margins, in the things that you are most likely to find expensive on a day-to-day basis.

No one notices that collectable figurines are suddenly more expensive. Or electric light bulbs. Or woolen slippers. You notice the rising prices of things you use like food and energy. To strip those out the rising cost of things you actually use from the inflation calculation renders the whole metric useless and limp, which is probably the entire point anyway.

This note from a reader on our blog over at http://www.dailyreckoning.com.au in response to our question about ANZAC day yesterday. "ANZAC day is about the men on that beach, Dan. Every Australian knows that the British strategy was flawed. But the focus is on the heroism of the men in helping their mates and doing their duty proudly not as British subjects but as citizens of an independent country. They fought for Australia, despite the fact that Australia still towed the line with Britain. It's about the non-militaristic warrior ethos, and the futility of war."

Fair enough. We've often heard about the Australian value of "mate-ship." And as the youngest of seven brothers, the idea makes inherent sense to us. You stick together when you need it most, because nobody else is there by your side.

Whether this means it is noble to die for your country, well that's a whole other question. Government's would have you believe it, otherwise it would be awfully hard to get people to go to war. More tomorrow, on ANZAC day.

Dan Denning
The Daily Reckoning Australia

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