The big economic news of the week was, of course, Thursday’s report on consumer prices. And there’s no way to spin that report: It was ugly. There has been a lot of buzz from private-sector observers to the effect that inflation is rolling over, but there was no sign of that in the official numbers. And the stock market responded to this ugly report by … gaining 800 points. No, I have no idea why.
But are the official statistics telling us what we want to know? There’s a huge temptation to “unskew” the numbers, excluding stuff you don’t like and stuff you do. That’s clearly a bad way to proceed. What I want to argue, instead, is that official measures of inflation, while well designed for their original purpose — measuring the cost of living — are ill suited to the policy question of the moment, which is how much the Fed needs to raise interest rates.
Most economists, though not all, believe that there’s a relationship between economic slack and the inflation rate. In other words, the hotter the economy is running, the higher — other things equal — inflation will be.
I agree with the conventional wisdom on this, and I’m agnostic about the issue of whether slack is best measured by the unemployment rate, the ratio of vacancies to unemployment or something else. I’m also reasonably sure that the economy is indeed running too hot, so the Fed was right to raise rates — although I’m much less clear about whether the Fed needs to keep raising rates, given that much of the effect of past rate hikes has yet to be felt.
But how can we best assess where we are?