Tuesday, June 23, 2009

Juiced Inflation Numbers Just Ahead?

The CPI number coming out of the Bureau of Labor Statistics has been relatively tame of late, partly due to seasonal adjustment factors. Bob Murphy took notice recently and wrote:
The trend continues. The actual CPI rose 0.3% in May--an annualized price inflation rate of 3.7%--but the BLS "seasonally adjusted" it down to 0.1%, which is a much more reasonable annualized inflation rate of 1.2%.
In a private email correspondence with Murphy, I wrote:

What I find, and this is pretty much a mathematical identity, is that the seasonal adjustments (up and down) balance themselves off over a year--really by definition.
And I continued:
The way they would monkey is if they changed the seasonal adjustment factors retroactively once it was time to increase the actual number. This would, of course, mean the current numbers wouldn't have so much of a downward revision--but no one would be looking at the current numbers, in say, October.
Murphy agreed.

Now comes along John Crudele at Nypo, who just loves to dig into BLS data methodology, and comes up with pretty much the same analysis:

For the past couple of springs the BLS, which is in charge of calculating the nation's inflation rate, has been understating the amount of inflation we are experiencing.

Here's what is happening.

Because we've had annual run-ups in the cost of energy these past few springs, the computers that calculate inflation at the BLS now tend to anticipate a jump in gasoline prices [RW: Technically, what the BLS is doing is attempting to smooth the climb in gasoline prices over 12 months, not ex-out anticipated increases].

The computers look at the past five years for guidance on their seasonal adjustments. In other words, they saw this spring's increase in gas prices coming.

And since it was expected, some of the rise in gasoline prices this year was subtracted out of the CPI by the seasonal adjustments.

Just look at the numbers that were reported by the BLS and repeated by the media.

Consumer prices rose just 0.1 percent on a seasonally adjusted basis in May compared with April. The index that measures energy prices rose 0.2 percent, but that was the first time in three months that there was an increase in energy costs.

Say it with me: How can that be?

You and I have both seen the price of gasoline go up and up at the pumps. Gas was a dollar a gallon cheaper last December and most of that increase has come in just the past few months as speculators anticipated (wrongly, it turned out) that people would do more driving and need more gasoline as the summer approached.

So why hasn't the CPI reflected that rising cost?

Because the BLS' CPI calculations -- see, it really is dry -- have gone kerflooey.

Wall Street doesn't understand this. In fact, the million-dollar economists at financial companies were expecting energy prices in the CPI to rise more sharply this spring and were disappointed.

Here's what they also don't know: Because the CPI understated the rise in energy prices these past few months the BLS' index will probably overstate gasoline prices in the coming months...

...here's the real problem with seasonal adjustments like this: What the computers give, they have to take away.

By definition, if the effects of increased gasoline prices are understated in the spring they need to be overstated at some other time.

In the end, the effects of these seasonal adjustments have to be neutralized. They must offset each other by the end of the year...
Crudele expects that this will translate into stronger inflation. He may be right. But, he does correctly add the caveat that a drop in gasoline prices could cancel out any upward seasonal adjustment in the CPI.

Crudele should have perhaps discussed a fall in declining gasoline prices with much more than just an aside in his column. With Bernanke now slowing money supply growth, it is quite possible that gasoline prices may drop significantly over coming months. So we may have countervailing forces in coming months on the CPI. Seasonal adjustment juicing the CPI, with actual gasoline price declines neutralizing the upward thrust.

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