The median is half way

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There is a bit of chatter – including from our Treasurer – that inflation is only due to a few once off factors. That is totally wrong.

The median CPI was 0.92%q/q in Q2, which means that one half of the CPI basket is inflating at a pace that is greater than that. This is an acceleration from the 0.81%q/q pace in Q1. So in both quarters, half the basket inflated at an above 3% pace (the RBA targets 2% to 3% across the cycle).

The RBA (and Fed) have done a lot of work on what gives the best real time measure of the inflation impulse. Their conclusion is that statistical measures such as the trimmed mean and weighted median are best. The RBA thinks that trimmed means are best, the Cleveland Fed thinks weighted median CPI, and the Dallas Fed thinks that the 6mma trim is best.

I like 2Q averages, and I like the weighted median best at a time like this, as it is less sensitive than trims to what i call the ‘Bradman effect’ – where lumpy price shocks (such as natural disasters) bias up the core estimate.The Bradman effect is the phenomenon that the trim increases when you add a few high inflating components (middle order batsman averages rise when you add a few Bradmans to the top order).

The 2Q average of the weighted median is 0.87%q/q, or 3.46%y/y AR. The trim, which the RBA prefers, is 0.92%q/q, or 3.66%y/y AR. The average of the two is 0.89%q/q, or 3.56%y/y AR.

Some are making a case based on the fact that the ex volatile, ex deposit and loan inflation was 0.5%q/q – but most people now think there is a trend in the price of volatiles, which is why central banks are dumping such measures.

When there was no trend in food and fuel prices, the exclusion measures (possibly) made sense, but I no longer think that is the case. Even Bernanke has started talking about statistical cores and is known to have steered the FOMC away from Greenspan’s focus on core PCE.

Some things are going up in price, and the RBA’s job is to make sure that other things go down in price. By refusing to accomodate the increase in some prices by expanfing the money supply, they enforce our collective budget constraint.

In my view, the RBA should hike ASAP and deal with the consequences of over-tightening if they are wrong about the mining boom. We have always had a problem with inflation when the unemployment rate is below 5% – I don’t think the folks in the RBA’s economic analysis department will think there is much mystery about this recent pickup in inflation.

The ‘it is only volatile items, wait for more data’ arguments remind me of the arguments coming-out of Asia last year, particularly in India.

Of course, all those central banks are now hopelessly behind the curve.


  1. Can’t compare Australia to India! :)

    Can you compare the world and domestic economy now to 2007/2008 when the RBA found itself behind the curve? I do not think so.

    Plus oil prices are lower now compared to last quarter already. Many food prices will come down in the next months. Core excluding food and fuel was 1% Q/Q in Sep 10, so if we get a lower number next quarter (highly probable), core Y/Y will come down further from 2.5%. AUD is higher. If you focus on the “non-volatile” inflation you’ll see it has been quite low compared to the last 2-3 years.

    The RBA can go ahead and rise rates next month if that makes them feel safer, but it won’t be the start of a series of rises IMO.

    1. I agree with your last point … This is unlikely to be the the start of a series of hikes. The RBA will need to be pushed by CPI every step of the way from now until the economy starts to look a little better. Tightening into weakness because inflation is high and you have a forecast of strength is an unnerving thing to do.

      Sent from my iPad

      1. There’s a paper by Bernanke, and others, supporting the thesis that oil price shocks do not cause recessions, rather the policy response associated to oil price shocks (i.e. rate hikes).

        1. Yes I am aware of that. And despite his focus on headline, B held rates steady and then cut in 2007 when inflation was surging due to the oil surge to 150/bbl. But is this an oil price shock? Or is it an uptrend in commodity prices due to rapid growth in the east?

          The right policy choice is 100% determined by the probability of a wage price spiral — which really comes down to what you think is going on with the labour market. We presently have full employment, rising wages, and a union movement itching to flex muscle. That is not the case elsewhere.

          1. My argument is that central banks should not hike rates just because of oil and food price increases only. Those are already a restrictive force on the economy. Next quarter we will have the lowest Y/Y “non-volatile” inflation in 4 years at < 2.4%

            If concern is full employment does it hurt to wait for the next few employment numbers? It looks like it is stabilizing around about 5%. If that goes down then pull the trigger.

            Beside the fact that we are talking about a small 0.25% increase, what do you think that will do to rising wages and a union movement itching to flex muscle, if not pushing them to ask for more money to repay their mortgages? Everything is going up, including mortgage repayments they say!

            We have a HUGE interest rate differential with the rest of the world already. Monetary policy is already restrictive according to the RBA (mildly). And I would not forget the extra increases that banks applied independently.

  2. you forget history.

    We got high inflation ,relatively, because of two rogue CPI numbers.

    The average of the two numbers the RBA looks at are now far too high.

    I think we will get a few hikes unless the economy is weakening as we write however I do not think it is.

  3. In my view, the RBA should hike ASAP

    Ummm … weren’t you forecasting November (or next year) like two weeks ago?

    You guys are hopelessly inconsistent. The non-mining economy (where 99% of us live) is perilously weak and a hike in this environment will crush confidence.

    1. Ahh yes here we go

      My money is now on November

      Nothing has changed. The AUD is still rampant. Fruit and veg are still cyclone/flood affected. Consumers are still on strike. Non-mining trade exposed sectors are still in a tailspin. Euro-debt problems still haven’t been resolved.

      And we’re all still waiting for Futureboom!

      1. Well, i was also forecasting 0.6%q/q for core CPI … As Keynes said, when I am wrong I change my mind. What do you do, sir?

  4. You stick to your guns and don’t flip flop around with every data release.

    Confidence is very fragile in non-mining Australia at the moment. Its taken a terrible beating over a carbon tax that’s 12 months away and wildly over compensated. Imagine what something real and immediate like a rate hike will do.

    The underlying drivers are all still the same: Consumers cautious, households deleveraging, trade-exposed sectors smashed, house prices falling … while being continually lectured about how we’re in the midst of a once-in-a-century boom.

    1. Well, good for you. Stick to those guns. My priors are not held with such confidence.

      Inflation is hard to forecast, a 30bps miss is big, and it is especially big as it tells me that I am more likely to be wrong in my estimate that much of q1 was due to a supply shock.

      Moving a hike forward three months is a pretty small deal, and seems in keeping with the new information.

      Sent from my iPad

      1. Peter Martin has a killer piece in The Age today.

        Higher fruit prices accounted for an astounding 39 per cent of the increase in the CPI. They won’t last. It’s easy to see that by looking at what happened to the price of vegetables. They shot up 16 per cent in the March quarter after the floods, and then slid back 10 per cent as crops regrew.

        Fruit trees take longer to regrow than vegetables, but they do regrow. Not only will the upward pressure from higher fruit prices soon leave the CPI, it’ll soon be replaced by downward pressure as fruit prices return to earth.

        You might think none of this should affect the Reserve Bank’s two underlying measures of inflation, the ones that came in at 0.9 per cent. You would be wrong.

        One of the measures, the ”trimmed mean”, is calculated by arranging all of the price movements in order of size, lopping off the top 15 per cent (of big movers) and the bottom 15 per cent (of small movers or price declines) and then averaging the price changes that are left. The other measure, the ”weighted median”, also arranges movements in order and cuts out everything other than the middle price change.

        How could an enormous price change like that for fruit boost those underlying measures? Not directly. Fruit would be excluded because it was one of the biggest price changes.

        But if it had previously been included because it was one of the mid-ranking price moves, it will knock one of the other big movers back into the mid-range to take its place – it will push up the trimmed mean indirectly.

        It is clear that has happened. A different measure – CPI ex volatiles and deposit and loan facilities – came in at just 0.5 per cent in the quarter and 2.4 per cent over the year.

  5. stick to your guns?
    Unless one argues the last two underlying numbers ( the average of the two RBA preferred measures) are rogue numbers you must raise rates and now.

    1. I was willing to write off the last one following GDP, but this one seems harder to explain. We have an inflation issue despite growth being only about trend, and unemployment not being especially low.

      Our inflation outcomes are pretty similar to our peers these last few quarters, so I think it is hard to sustain these special factor arguments.

      Sent from my iPad

    2. The RBA told us they will discard food inflation, due to the natural disasters, and we all know where oil prices are coming from. Best time to focus on inflation excluding food and fuel (called excluding ‘volatile’)
      There’s currently no problem with that.
      Anyway…. c’mon RBA: raise rates while the ASX is plunging and the AUD at record levels! cheers

    3. Peter Martin made the entire economic commentariat and blogosphere look like amateurs today.

      The inflation ‘problem’ is a figment of the bullhawks fevered imagination. Lets hope Stevens and Battellino stop carrying on like old generals fighting the last war (2007) and wake up to the fact that 2011 is a very different situation.

      Score one for Bill Evans.

      1. okay — what’s your 1 year ahead forecast for some measure of inflation? pick one (i suggest the WM, but choose your own adventure). I’ll forecast it too, and i’ll see if Chris wants to do so also, and we can see who has the best guess come Q2’12 CPI.

        what Peter Martin describes is what I call the Bradman effect. I described it in this post.

        I agree that it’s an issue for the trim, but i don’t think it makes the exclusion based measures better than the weighted median. you would have to have a lot of confidence that all our inflation is only temporary to make that call. I don’t think it’s possible to have such confidence.

        the RBA had a forecast of inflation accelerating to 3.25% in their Q2 SOMP, and while 2011 growth will be weaker, it is unlikely to be weak enough to take the projection back under 3% given the higher starting point.

        i suspect that the ‘1’ Bill scored was an own goal … inflation is real, it’s happened.

        If we had weak unit labour cost growth (or equivalently low wages growth relative to productivity) the RBA could afford to ignore it — but with the fair pay commission setting the standard by making a headline based adjustment to nominal wages, i don’t think the RBA will take that risk.

        let’s face it, they thought they were going to have to tighten anyways.

    4. i suspect that the ’1′ Bill scored was an own goal … inflation is real, it’s happened

      I suspect that what inflation there is not due labour cost growth, its due to one-off events.

      I’m not in the game of forecasting one year out, especially not at the moment with Europe lurching from crisis to crisis, the US self-destructing, and China in a last phases of a manic investment/credit bubble.

      Bill is right because the domestic economy is far, far weaker than most have acknowledged, and if there’s any move this year or next it will be down not up.

      This is not 2007. The RBA is fighting the last war.

      1. Bill Mitchell has an even more comprehensive debunking of Australia’s inflation ‘problem’.


        The inflation rate has risen steadily this year mainly due to transitory factors such as natural disasters and external factors (petrol prices). Only the energy price issue is of concern. The farms damaged by the floods etc will be back into production before long and then the supply boost will see food prices fall sharply.

        Related data shows there are no signficant generalised wage pressures in the economy at present. It is also clear that the overall economy is slowing and at least one major banks (and the swaps market) are betting on a fall in inflation. The retail sector is now probably in recession.

        The madness in Europe and the US at present is also conditioning a negative outlook.

        We can look forward to a series of embarrassing back downs from inflation hawks over the next few months. Joye, Carr, Bloxham et al will have egg all over their faces. Of course, they’ll never admit it. Lets hope sanity prevails at the RBA next week, and Battellino gets rolled by the board members who live in the real world.

        1. Unless he has changed his mind in the last ten years, you should know that bill thinks inflation is all supply driven. Anyhow, I would say Bill has debunked himself — the cores accelerated, and the RBA doesn’t wait until year on year measures are over 3% to hike.

          “The special measures that the RBA uses as part of its deliberations each month about interest rate rises the trimmed mean and the weighted median also showed moderating price pressures.

          the RBA-preferred measures are still well within the inflation-targeting band of 2-3 per cent. So there is no justification for a rise in interest rates to follow todays release”

          Sent from my iPad

  6. Can’t see RBA going before a debt deal is done.

    Crazy otherwise. Why not wait a month

  7. By the way, I dont agree with Peter Martin. Why switch to a different measure now? Sure a natural disaster but what is the rationale for excluding fuel?

    But Treasury basically writes Peter’s pieces so that’s probably the arguments Tsy are taking to Board next week. With business probably against a raise, another time where the RBA gets rolled?

    1. i agree, dr page. they are unlikely to go in August without a debt deal being done.

      however, i think that they should do so. i think it’s the clearest thing to do. when inflation is too high, they raise rates.

      on a related matter, in theory the thing about inflation targets is that it doesn’t matter what’s in them or what they are. central banks should just pick some measure, and stick to it – that’s the best way to stabilise expectations and provide a nominal anchor. and that’s all monetary policy can do in the long run.

    2. If Treasury does write Peter’s pieces — and from what I hear there’s some truth to that — then perhaps everyone should be taking it more seriously.

  8. Tim Colebatch: The CPI is not a credible basis for policy action

    Consumer confidence has fallen back to GFC levels. Business confidence is below sea level. In this environment, you need a very, very good reason to raise interest rates and the CPI is not it.

    It shows inflation is low in most of its 90 sectors of consumer spending. In the year to June, a third recorded falling prices, a third recorded rises within or below the target, and a third recorded price rises above 3 per cent.

    It is a similar story even in the first half of 2011. The unweighted median price rise of those 90 items was well inside the Reserve’s target zone. But the weighted median was outside it, partly because the index over time overstates our spending on items with rising prices, and understates spending on those with falling prices.

    Take bananas and computers. When this series began in 2005, fruit and vegetables comprised 2.1 per cent of our spending, and computers 1.5 per cent. But fruit and vegetable prices have soared since cyclone Yasi, while computers now pack far more power than in 2005.

    But the bureau assumes we still buy just as many bananas, even at $12 a kilo, and buy 2005-strength PCs very cheap. So the CPI is estimated on the basis that fruit and vegetables now comprise 3 per cent of our spending, and computers just 0.5 per cent. And that is wrong.

    Likewise the CPI seriously overstates our spending on tobacco, and understates spending on mobile phones. And when the weights are wrong, that means the data itself is also wrong.

    The Reserve faces a tough call. But it must not jump at shadows. This is a weak economy; it has time to wait. The next CPI figures will be based on a 2009-10 survey of household spending. That will restore the CPI as a credible basis for policy action.

    1. I agree, a chain weighted CPI would be better. However the argument that the economy is weak therefore we don’t need hikes seems to me to miss the point that the state of the economy really only help forecast CPI when the unemployment rate is high and rising. It is steady just now, at a level at which we have always had trouble with inflation.

      Sent from my iPad

      1. Again, you are re-living 2007 when the economy was going gangbusters across the board. That clearly isn’t happening now. If you think it is, I suggest you climb down from your ivory town and spend some time on the ground.

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