Recession?

Are we in a recession?  CNN puts the word 'recession' in quotes.  Warren Buffet says we are there today, and Greenspan says we probably will be soon.  Americans feel that they are in recession.  Yet there is a cut and dry definition of recession - two consecutive quarterly declines in real GDP - and by this measure, we are not in recession.

Or are we?  This technical measure of recession is not as cut and dried as it may sound.  The problem comes with how we measure inflation.  The Motley Fool explains why we feel that inflation is higher than what the government reports.  This may not  be as sinister as it sounds: with items like milk and gas skyrocketing, we are reminded daily of price increases, but less frequent purchases, like big ticket electronics, are dropping in price. This is not an anti-government rant - I am just pointing out that measuring inflation is not cut and dried.

Bill Gross, the bond expert at Pimco, writes that CPI has chronically be understated by 1%.  This is because of the use of 

• substitution effects: if you buy chicken instead of beef because beef prices increased, the government does not view this as inflation.
• "core" CPI that excludes food and energy: if it costs you 25% more at the supermarket every week, this is not inflation!
• hedonic quality adjustments: if you buy a more powerful computer for the same price - the government views this as deflation!
• rent-equivalent housing costs.  if it costs you more to buy a house, but rents stay the same, this is not inflation according to the U.S.

Gross estimates the net of all this is that inflation is understated by 1% and has been since the nineties, when most of the above inflation-adjustments were initiated.  (The lone exception was using core CPI, which Nixon introduced to keep inflation data relatively stable in the face of sudden OPEC price moves.) Most of these adjustments to inflation are unique to the U.S. 

If inflation is understated by 1%, you can make the argument that we are "technically" in recession today. Certainly this would jibe with what most Americans have been experiencing.

Even more worrisome, consider these impacts of underreported inflation:

• We have been chronically overstating our GDP.
• Our vaunted productivity gains have been overstated.
• Bond and TIPS have 1% lower real-yield than is typically reported.  This is about half of their expected real return!

In other words, in irony of ironies, our fairy tale Goldilocks economy may have been, after all, simply a fairly tale.

Comments

[David Neubert]

Good reading. I thought of what this means for investing a bit. I couldn't help but expand (or contract) your post on my own blog.

[Deborah]

You forgot a couple more examples of inflation:
1. Manufacturers charging the same or more for less product.
2. Taxes and fees.

[Craig Blitz]

Deborah,

Thanks for your comment.

I agree there are many other vagaries when measuring inflation. The four I mentioned are changes in the past 35 years in how we measure inflation that tends to differ from other countries.

I tend to think what the two examples you cite are examples of more consumer pain and cause for belt-tightening by some, but I am not convinced they lead to higher inflation.

For example, you may have to pay the same for less product, but in some cases, product features we used to pay for are now free. These are what hedonic measures are for. An interesting example is the plane ride I took to Santa Fe this week: a meal is no longer included. Is this inflation? I don't know - what if I didn't want the meal in the first place? Oh, and I didn't pay for the flight since it was purchased by frequent flyer mileage, accumulated while doing business-related travel. There's certainly a lot of room for interpretation in that flight.

I have similar questions about how taxes should be accounted for: when the government takes my money and gives it too someone needier, I don't think that is inflationary, even if they take more from me this year than last. When they use it to purchase other goods (missiles, for example), it simply moves money from my discretionary income to the government. Neither of these are inflationary, even if they are painful for my finances. In the former cases, it may look 'deflationary' the person receiving more government benefits.

Now when the government prints money - when it spends on a deficit - that creates inflation. But that is different - it is not inflation until it is measured in the price of goods.

Craig

[WoW Gold]

The recession really is affecting everyone globally. Everyone should be helping each other to make it through, specially the government.