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So what's the idea here? That oligopolistic/regulated prices have inertia and free competition prices don't, and the "real inflation" is in the free competition prices? This is nonsense for a variety of reasons.

First of all, the more capital-intensive an industry is the more it tends to oligopolistic/regulated prices. So, if you're going to exclude them from the price index because they exhibit inertia even if they have a large impact in consumers' shopping baskets or in economic flows generally, you're measuring something useless.

Second of all, I have recently developed this intuition that the more volatile prices and volumes are, the more inflation there is [for the physicists: I'm thinking this is related to the fluctuation-dissipation theorem - if I understood the latter I'd be able to tell you for sure]. So, if an industry sector displays price inertia, it should also display lower inflation than average. And so, by excluding it from the analysis, you get a high inflation estimate.

So, what are we doing? We're excluding the capital-intensive sectors of the economy from the price index, and we're introducing an upwards bias in the inflation estimate. Coincidentally, Krugman just wrote:

And all of this has a real, damaging effect on policy. The econ team at Goldman Sachs (not online) makes the interesting point that FOMC inflation forecasts are pulled up by a small group that keeps forecasting much higher inflation than anyone else; this in turn helps limit the Fed's willingness to support the economy. And the deficit hawks have, of course, killed any hope of more stimulus.
FOMC is the Federal Open Market Committee at the Fed.

By laying out pros and cons we risk inducing people to join the debate, and losing control of a process that only we fully understand. - Alan Greenspan
by Migeru (migeru at eurotrib dot com) on Sun May 23rd, 2010 at 02:55:01 AM EST

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