Krugman's Most Embarrassing Comment Ever

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With commodity prices soaring, Paul Krugman is in a trap with his deflation call, so he has decided to turn to Richard "I am not a crook" Nixon to explain why price inflation is really not happening.

Krugman tells us to forget about the prices that are going up. They are too volatile, he tells us. He says that what we should focus on are tricky sticky price indexes, specifically, core CPI.

The problem with this is that core CPI was designed at the request of Tricky Dick Nixon to hide real inflation. Here’s the story of what went down:

Kevin Phillips, a political and economic commentator for more than three decades and onetime Nixon strategist, reports that President Richard Nixon asked his Federal Reserve chairman, Arthur Burns, to concoct a new inflation number that would be split off from traditional headline CPI, dubbed “core” inflation — and thus make inflation look less threatening.

Writes Phillips:

Richard Nixon, besides continuing the unified budget, developed his own taste for statistical improvement. He proposed albeit unsuccessfully — that the Labor Department, which prepared both seasonally adjusted and non-adjusted unemployment numbers, should just publish whichever number was lower. In a more consequential move, he asked his second Federal Reserve chairman, Arthur Burns,to develop what became an ultimately famous division between "core" inflation and headline inflation. If the Consumer Price Index was calculated by tracking a bundle of prices, so-called core inflation would simply exclude, because of "volatility," categories that happened to he troublesome: at that time, food and energy. Core inflation could be spotlighted when the headline number was embarrassing, as it was in 1973 and 1974. (The economic commentator Barry Ritholtz has joked that core inflation is better called "inflation ex-inflation" — i.e., inflation after the inflation has been excluded.)

Phillips says in the 1990s, the CPI was subjected to three other adjustments, all delivering a downward bias and all dubious:

  • Product substitution: If flank steak gets too expensive, people are assumed to shift to hamburger, but nobody is assumed to move up to filet mignon, he says;
  • Geometric weighting: Goods and services in which costs are rising most rapidly get a lower weighting for a presumed reduction in consumption
  • And, most strangely, hedonic adjustment: An unusual bit of monkeyshines by which the government says that product improvements in things like computers, cell phones or television actually amount to a reduction in price, so a $2000 laptop with a built in camera is less expensive than a $1500 laptop without one.

This is the index that Krugman has decided to base his deflation case on. Yes, deflation! Even though the manipulated core index is up! I an not making this up. Here’s Krugman:

There’s really nothing here to shake my view that deflation, not inflation, is the threat.

Here’s the core CPI starting Jan 2009:

Using this sleazy core index, Krugman then divides the PPI by it. Which proves that Krugman once again doesn’t understand the business cycle, since coming out of a recession, it will be capital goods prices and raw materials prices that climb first. Thus, he is trying to prove his deflation case by showing what any decent business cycle theorist would understand to be the way you would expect prices to move before you get inflation at the consumer level.

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©2010 Economic Policy Journal

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