The Big Picture

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• Why Do Measures of Inflation Disagree?
• Succinct Summation of Week’s Events (12/13/13)
• Comedians in Cars Getting Coffee
• Josh Brown: Investment Fads and Themes
• More American Households Rely on Government Benefits
• 10 Friday Reads
• What Kinds of Errors Are You Making (and what are you doing to fix them?)
• 1967 Toyota 2000GT
• The Copenhagen Wheel

Why Do Measures of Inflation Disagree? Posted: 14 Dec 2013 02:00 AM PST Why Do Measures of Inflation Disagree? Yifan Cao and Adam Hale Shapiro FRBSF Economic Letter December 9, 2013     Inflation as measured by the personal consumption expenditures price index is near historical low levels, below the Federal Reserve's 2% longer-run goal. Another common inflation measure, the consumer price index, is also historically low, but remains closer to 2%. The recent gap between these two measures is due largely to the cost of shelter, which makes up a larger proportion of the CPI consumption basket. Based on history, the gap between the two inflation measures should close at a rate of 0.05 percentage point per month. In January 2012, the Federal Reserve's policymaking body, the Federal Open Market Committee (FOMC), announced it judged "that inflation at the rate of 2%, as measured by the annual change in the price index for personal consumption expenditures (PCEPI), is most consistent over the longer run with the Federal Reserve's statutory mandate" (Board of Governors 2012). The consumer price index (CPI) is an alternative inflation measure with a longer history. Like the PCEPI, the CPI is closely monitored by the FOMC and numerous private-sector firms and government agencies to track price movements. These two inflation measures tend to move closely together, though the CPI has tended to increase a bit faster in the past. Currently, annual CPI inflation excluding volatile food and energy prices is 0.5 percentage point higher than the comparable PCEPI core inflation measure. This Economic Letter examines the principal differences between the PCEPI and the CPI, and why their rates of inflation do not always align with one another. Their recent divergence can be explained largely by differences in how each measure accounts for consumer shelter costs. However, historical data imply that the two inflation measures should close much of this gap. Furthermore, when CPI inflation exceeds PCEPI inflation, it tends to slow towards the latter to close the gap. A tale of two measures The Bureau of Labor Statistics (BLS) first developed the CPI in 1913. The index is based on reports from retailers and tracks the price level for a basket of goods and services purchased by a typical urban consumer. The PCEPI is produced by the U.S. Commerce Department's Bureau of Economic Analysis (BEA) based on the same national accounts data used to estimate gross domestic product. For most of its history, the Federal Reserve used the CPI to set policy and forecast inflation. However, in February 2000, the FOMC began using the PCEPI to frame its inflation forecasts. The PCEPI and CPI share many of the same features. For example, the PCEPI, like the CPI, is designed to track the prices of goods and services consumed by households, and it includes much of the same data. However, the PCEPI differs from the CPI on many dimensions. The FOMC cited three of these as reasons for switching its focus from the CPI to the PCEPI (Board of Governors 2000). First, the PCEPI's formula adjusts to changing consumption patterns, while the CPI is based on a basket of goods and services that is largely fixed. Second, the PCEPI is revised over time, allowing for inflation to be tracked as a more consistent series. Third, the PCEPI's larger scope of goods and services provides a more comprehensive picture of the nation's consumer spending than the CPI. Figure 1 Core CPI and PCEPI inflation, 2003 to present Sources: Bureau of Economic Analysis, Bureau of Labor Statistics. Figure 1 shows the year-over-year change in core CPI and PCEPI inflation over the past 10 years. These core measures exclude food and energy prices, reducing volatile short-run movements in the indexes. Core measures are better able to capture the underlying longer-term trends in inflation. The figure shows that core CPI and core PCEPI inflation measures are highly correlated, but that gaps frequently arise between them. Since August 2011, annual core CPI inflation has outpaced annual core PCEPI inflation by a minimum of 0.20 percentage point and an average of 0.34 percentage point. This is the longest sustained gap between these measures in the past 10 years. What explains the gap between CPI and PCEPI inflation? There are many reasons for the discrepancy between the CPI and PCEPI, but the differences can be summarized into questions of scope and weight. Differences in scope refer to goods and services included in one index basket but not the other. For example, in addition to direct spending by consumers, the PCEPI includes purchases by nonprofit organizations and those made on behalf of consumers by employers. By contrast, the CPI includes only direct, out-of-pocket consumer expenditures. The PCEPI also fluctuates differently than the CPI because of variances in the weight of specific goods and services in each consumption basket. In other words, specific goods and services may make up different proportions of each basket. This weighting is meant to capture the consumption habits of individual households and determines the importance of a specific good or service in the index. For example, because the CPI only measures out-of-pocket consumer expenditures, it places a lower weight on health expenditures, which are often partially paid for by employers. Two primary reasons explain why weights differ in the CPI and PCEPI: first, how often the weights are updated; second, the relative size of the weights in each basket. The CPI updates weights every two years, while the PCEPI updates them quarterly. The BLS method for the CPI is called a "fixed basket" approach, while the BEA method for the PCEPI is known as a "chained" approach. Broadly, this means that the CPI assumes that consumers change their purchasing habits every two years, while the PCEPI assumes that consumption habits change quarterly. Since 2000, the BLS has also produced a chained CPI to address this issue. The discrepancy in using a fixed versus a chained basket is actually small. The BEA estimates that since 2011 this difference has generated an average variation of only 0.14 percentage point between annualized CPI and PCEPI inflation. By contrast, the difference in the size and distribution of the weights in the indexes has a more significant impact on the gap. The BEA judges that since 2011 the difference in weights caused on average a 0.56 percentage point difference between CPI and PCEPI inflation (CPS 2012 and BLS 2012). To put this in perspective, the average difference between overall CPI and overall PCEPI inflation over this period was 0.58 percentage point. One way to see how the difference in the weights has affected the gap between CPI and PCEPI inflation is by looking at shelter prices. Importantly, neither index uses actual house prices to determine owner-occupied shelter prices. Rather, these prices are based on the BLS's Consumer Expenditure Survey, which asks households how much their homes would cost to rent on the open market. Shelter currently takes up 32% of the CPI consumption basket, but only 15% of the PCEPI basket. This difference reflects the larger scope of goods in the PCEPI, which dilutes the weight of shelter in its consumption basket. Overall, the CPI's larger weight on shelter means that it is more sensitive to shelter price movements than the PCEPI. The BEA estimates that, since 2011, the difference in these shelter weights has caused a 0.31 percentage point difference between CPI and PCEPI inflation. This accounts for more than half of the 0.56 percentage point weight-based effect over the recent period. Figure 2 Role of shelter prices in overall inflation gap since 1963 Sources: Bureau of Economic Analysis, Bureau of Labor Statistics. Figure 3 Shelter inflation and inflation gap, 2009 to present Sources: Bureau of Economic Analysis, Bureau of Labor Statistics. Figure 2 illustrates the role of shelter prices in the overall inflation gap between the two indexes. The horizontal axis measures the gap in percentage between CPI shelter price inflation and core PCEPI inflation, based on 12-month changes. The vertical axis measures the gap between core CPI and core PCEPI inflation. The upward-sloping line shows a positive relationship between the two gap measures. The slope is approximately 0.5, indicating that, on average, when shelter price growth exceeds core PCEPI inflation by 1 percentage point, CPI inflation exceeds core PCEPI inflation by 0.5 percentage point. Figure 3 compares recent shelter price inflation with the gap between annual core CPI inflation and core PCEPI inflation. The inflation gap falls and then rises in tandem with shelter price inflation. Thus, the recent steady increase in shelter prices relative to other prices is a major factor driving the sustained increase in CPI inflation relative to PCEPI inflation. How does the gap usually close? Given that gaps between these inflation measures widen and narrow over time, we can assess how the gap has closed on average historically. To do this, we construct an error-correction model to answer two questions. First, if CPI inflation and PCEPI inflation are different, do they typically converge at some point? Second, which of these two inflation measures typically moves most to close the gap? We estimate that on average, when the two measures have diverged in the past, core CPI inflation has generally moved more to close the gap. This convergence is generally quite slow. For every 1 percentage point gap between the two measures, core CPI inflation typically moves 0.05 percentage point per month towards core PCE inflation. This suggests the current 0.5 percentage point gap will probably disappear in approximately 10 months. Conclusion Core CPI inflation is currently 0.5 percentage point higher than core PCEPI inflation. Historically, gaps of this size are not unusual and have primarily been driven by the differences of the weights the two indexes put on various items in their consumption baskets. For the most recent gap, the CPI's larger weight on shelter is a major reason why that index has exceeded PCEPI inflation. Based on historical patterns, we expect core CPI inflation to move back gradually toward PCEPI inflation. Yifan Cao is a research associate in the Economic Research Department of the Federal Reserve Bank of San Francisco. Adam Hale Shapiro is a senior economist in the Economic Research Department of the Federal Reserve Bank of San Francisco. References Board of Governors of the Federal Reserve System. 2000. "Monetary Policy Report to the Congress (Humphrey-Hawkins Report)," February 17. Board of Governors of the Federal Reserve System. 2012. "Longer-Run Goals and Policy Strategy." Press release, Federal Open Market Committee, January 25.

Succinct Summation of Week’s Events (12/13/13) Posted: 13 Dec 2013 12:30 PM PST Succinct Summation of Week's Events: Positives: 1) Retail Sales in November were above expectations and October was revised higher helped by good auto, furniture and building material sales. Online retailing and electronics also gain solidly with clothing and department store sales more muted. 2) Business Inventories in October rise .7% m/o/m, more than twice expectations and at the fastest pace since January led by wholesale inventories (prescription drugs and agricultural products) and retail auto dealers. This gain combined with the better retail sales data for both October and November leads us to raise our Q4 GDP forecast to closer to 2% from 1.5%. 3) Wholesale inflation benign in November as headline PPI falls .1% m/o/m and grows just .1% at the core as commodity prices continue to weigh on prices. Watch for services inflation in next week's CPI as that has been more sticky. 4) Both refi and purchase applications rose on the week by 2.1% and .9% respectively but comes after declines of 17.5% and 4.1% last week. The average 30 yr mortgage rate rose to 4.61%, the highest since September 20th according to the MBA. 5) As it's becoming very clear that the Fed will be focusing more on the weapon of 'forward guidance' with short rates, the 3 yr note auction was good but 2 yr and 3 yr yields do close the week at two month highs. With influencing the yield curve, forward guidance is only as good as one's crystal ball. 6) A budget deal, however modest (ZERO focus on long term budget busters), gets consummated. House votes yes, Senate likely will next week. 7) The November NFIB small business optimism index was 92.5, about in line with the forecast and up from 91.6 in October but still below 93.9 in September. Five years in to this recovery and the NFIB index still remains below the 20 year average of 97.6 as the weight of regulation, higher taxes, Obamacare, etc… on small business remains clear. 8) In China, exports in November rose 12.7% y/o/y, well above the estimate of 7% but import growth was a bit below expectations. Also of note, CPI in November rose 3% y/o/y, down from 3.2% and slightly below the estimate of 3.1%. The moderation was led by a slower rate of increase in food as non food prices rose 1.6% for a 3rd straight month. 9) Australia reported a greater than expected increase in job growth but the unemployment rate ticked up to 5.8% from 5.7%, matching the highest since August '09. 10) French business sentiment rose 1 pt to the highest since May '11 as likely the ECB rate cut last month boosted optimism. 11) Italy's Q3 GDP was revised to unchanged q/o/q from the initial report of down .1%. It's the 1st time since Q2 2011 that their economy has not contracted q/o/q. Also, Italy reported its smallest y/o/y drop in industrial production in October in 26 months, falling by .5% y/o/y which was better than the estimate of a decline of 2.2%. 12) Central banks in South Korea, Indonesia, Philippines, New Zealand and Switzerland end the year with no change in policy. Negatives: 1) Treasury sells longer term 10 and 30 yr paper to a pretty lackluster reception with the 10 yr yield in particular rising to a 3 month high in response. Also of note, the Japanese 10 yr JGB yield closes the week at an 11 week high. 2) Initial Jobless Claims spiked by 68k to 368k, well above the estimate of 320k but we should average the last two weeks to normalize for the Thanksgiving holiday which gives us 334k to analyze which compares to 321k and 326k in the two weeks prior. 3) For the 3rd week in a row I include the Investors Intelligence weekly sentiment data as the extreme nature of the survey deserves attention from anyone that considers the usefulness of contrarian indicators. Bulls rose again to 58.2 from 57.1 and is just shy of the highest level since October 2007. Bears remained unchanged at 14.3, the lowest since 1987. The 4 week average ratio of bulls divided by bulls+bears equates to 79.5% which compares with 73% in October 2007. 4) In October, the EU (all 28 countries) industrial production figure fell 1.1% m/o/m which was below the estimate of up .3% with declines seen in Germany, France and Italy among others. 5) The euro stickiness above 1.37 vs the US$ pressures European stocks with the Euro Stoxx 50 index closing at a 2 month low. The FTSE does as well (interest rate worries) and the CAC closes at a 3 month low. 6) Excessive credit growth continues in China as aggregate financing in November jumped higher by 1.23T yuan vs 856b in October and was well above the estimate of 920b. There is also chatter that within days Chinese officials will officially lower their 2014 GDP growth target to 7% from 7.5%, though likely more sustainable and realistic if it were to occur. 7) Japan's economy in Q3 was revised to a slower pace of gain than initially reported. It was changed to a rise of 1.1% annualized vs the 1st read of 1.9% and down from 3.6% in Q2. Also, led by a record increase in imports thanks to higher energy costs, Japan's current account went into an unexpected deficit in October for the 1st time since January. The yen hovers at 5 year lows vs the US$ in response. ~~~   Peter Boockvar Managing Director Chief Market Analyst The Lindsey Group LLC E:  peter -at- thelindseygroup.com www.thelindseygroup.com

Comedians in Cars Getting Coffee Posted: 13 Dec 2013 11:30 AM PST Is that Howard I hear . . . ? Source: New Year's Resolution. Watch More Comedians in Cars Getting Coffee.

Josh Brown: Investment Fads and Themes Posted: 13 Dec 2013 10:30 AM PST Source: Reformed Broker   Every year, my colleague Josh Brown puts out a collection of “Investment Fads and Themes.” This year is no different. His half dozen themes for 2013 (in no particular order) are Elon Musk Stocks, Smart Beta, Long Nikkei/Short Yen, Bitcoin, Buybacks, and Carl Icahn: American Badass. Rather than try to explain any of these, I will instead suggest you check out the multicolored chart attached, then read Josh's full commentary here. Makes for good weekend reading!   Continues here

More American Households Rely on Government Benefits Posted: 13 Dec 2013 08:30 AM PST Source: U.S. Census

10 Friday Reads Posted: 13 Dec 2013 07:30 AM PST Happy end of the week. Some reads to get you ready for the weekend: • Investing 2014: The Smart Money Is on European Stocks (Fiscal Times) but see also US Stocks Cheap on 12 of 15 Historical Valuation Measures (Reformed Broker) • Stock rise boosts pensions' funding to 96%, from 77% (WSJ) • Eisinger: Soothing Words on “Too Big to Fail,” but With Little Meaning (DealBook) see also It's Hard to Summon Sympathy for Big Banks (NY Times) Continues here

What Kinds of Errors Are You Making (and what are you doing to fix them?) Posted: 13 Dec 2013 06:15 AM PST It is an annual event that comes with the regularity of Thanksgiving and holiday shopping. I am referring to the Black Friday survey that the National Retail Federation conducts every year, in their misguided attempt to forecast holiday sales. As we discussed a few weeks ago, the National Retail Federation Black Friday survey is nonsense. Money in the bank, a sure thing, a can't miss bet, it has been wildly wrong each and every year. Once again, in 2013, they did not disappoint. As the most recent data shows, they got it wrong. Again. And not only in magnitude, but in direction as well. The most charitable comment I can make is that they did not miss as wildly as they have in prior years. The mathematician in me wants to point out that the merely poor – as opposed to awful – results could have been the result of randomness. Given the NRF's past track record, even if they nailed to the second decimal place, I would be compelled to chalk it up to dumb luck. But this column is not about me beating my chest, telling you I was right. Hell, who really cares that the National Retail Federation got Black Friday wrong for the 10th consecutive year. For anyone on the opposite side of the trade with the NRF, that has become a given. Since its Friday, I'd rather wax philosophical about headspace and intellectual approach rather than focus on the details of any one monthly retail sales report. Let us discuss information sources, methodologies, and precisely the choices we choose to make when we select what to believe. This is a much more significant point than many investors and traders realize.    Continues here

1967 Toyota 2000GT Posted: 13 Dec 2013 03:00 AM PST My pal Jan has one of these for sale; Its a 100 point car, The Toyota 2000GT been called Japan's million-dollar E-type, going most recently for $1.2m. I think I can save you a few $100k on the car if anyone wants to buy one . . .       Source: RM Auctions

The Copenhagen Wheel Posted: 13 Dec 2013 02:30 AM PST   Pre-order at http://www.superpedestrian.com This is the first commercial version of the Copenhagen Wheel. Now available for sale. Own a limited edition, hand-crafted Copenhagen Wheel, invented and built in Cambridge, MA. The Copenhagen wheel Technical specifications: MOTOR US: 350W / EU: 250W WEELE SIZE 26″ or 700c rim BATTERY Removable 48Volt Lithium CONNECTIVITY Bluetooth 4.0 BATTERY LIFE 1000 cycles SMARTPHONE OS iOS, Android CHARGE TIME 4 hours COMPATIBILITY Single Speed or 9/10 Speed Free Hub (email us your bike specs if you have doubts: info@superpedestrian.com ) TOP SPEED US: 20 mph EU: 25 km/h BRAKE TYPE Rim brake and regenerative braking (downhill and back-pedal) RANGE Up to 50 km / 31 mi WEIGHT 5.9 kg / 13 lbs DROPOUT 135 mm Many of you ask about the Copenhagen wheel’s relation to the TV show Weeds. the answer is yes, Weeds used it in their show during a whole season, they were granted the permission to use it by its inventors at the MIT SENSEable City Lab.

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