Bernanke Believes in Black Science – Hedonics

Bernanke said it again yesterday:

Inflation remains quite low: Over the 12 months ending in December, prices for all the goods and services purchased by households increased by only 1.2 percent.

He did mention the pesky problem of inflation in some of those “non core” things that we spend money on:

We have recently seen significant increases in some highly visible prices, notably for gasoline. Indeed, prices of many commodities have risen lately.

Ben made it clear to me (and the market) that he was not going to slow down QE2. The monetary pedal will remain stuck to the metal:

We will review the asset purchase program regularly in light of incoming information and will adjust it as needed to promote maximum employment and stable prices.

Bernanke continues to sell QE on the basis that inflation is too low. He was very specific in his definition of inflation. I’ll repeat his words from above:

Prices for all the goods and services purchased by households increased by only 1.2 percent.

Bernanke is using the CPI to defend QE. The CPI is the wrong measure for many reasons. Not the least of them is hedonics pricing.

The definition for hedonic is “relating to pleasure”. That sounds good, but when it comes to the CPI hedonics creates big distortions. The most common example is with technology. Consider an Apple computer.

In 2006 it cost $2,499 to buy a 15-inch Mac Book Pro with a 2.0 GHz processor. Five years later you can buy a 15-inch Mac Book Pro with a 2.53GHz processor for only $1,999. Adjusted for inflation and considering the increased capacity of the newer Apple the actual cost of “pleasure” has fallen by more than 30%.

When you add in one component of the index that is “falling” in value at a rapid pace and add it to another item that is actually rising you get an index that says that prices aren’t going up. Absolute hogwash.

Ben actually understands that weird things like hedonic pricing models distort CPI as a measure of inflation. He chooses to use this statistic as it supports his QE policy. He’s wrong and he knows he’s wrong. But the head of the globe’s central bank keeps blowing smoke at the press and lying to the public.

The good news is that the bond market is not buying into Bernanke’s spin. At the moment that is the only crowd that counts:

Articles on this topic: WSJ, Andrew Biggs

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