A statistical model is a simplification of reality that focuses attention on a few items that people can control that might make a difference in what the model is trying to predict.
A model isn’t reality. Reality is way more complicated than most people want to consider.
When a model works, it should produce results (forcasts) that make common sense.
When a model doesn’t work, it produces results that contradict real world experience.
That’s where the Federal Reserve is now.
- The Fed thinks the economy is picking up. That should mean rising inflation — but it doesn’t, this time. After a spike at the beginning of the year, the consumer price index is showing growth of less than 2%.(1)
- The Fed thinks the labor market is strengthening. My the logic of supply and demand, that should mean increasing wages. That’s not really happening either. The current month shows an increase in wages of 2.2% over a year earlier.
Models fail for two reasons:
- Some factor or variable is missing that’s impacting reality, or
- The data used the calculate the model is wrong.
In this case, the problem might be with both.
Here’s my list of possible problems:
- Measurement of inflation is wrong. The CPI as it is currently calculated understates price increases in both healthcare/insurance and food.
- The government measures food cost changes by looking at prices in the Washington, DC, area. That’s one of the most expensive regions in the US. When you divide an increase by a larger base number, you get a smaller percent change. This procedure is distorted, but it helps to reduce cost-of-living increases for people on Social Security.
- The government understates the proportion of income going to healthcare and health insurance.
- Bottom line: Inflation is higher than the government reports.
- Measurement of unemployment is wrong. The government treats anyone no longer calling or visiting employers to find a job as no longer unemployed. Meaning if you’ve been looking for six months, have called everyone you know and are now puttering making bird houses to sell, you are no longer unemployed. If you’re on Social Security and need additional income to make ends meet, you’re not unemployed. The real unemployment rate is 2x to 3x what the government publishes.
- The nature of work has changed. Workers are still being moved from higher-paying to lower paying jobs, and the “gig economy” means that jobs are short-term, unstable and include no benefits (e.g., health insurance). Plus more people are working part-time, which means the number of people working two or more jobs as increased. The Fed model doesn’t deal with that.
You may have more thoughts about what’s wrong with the government numbers. Tell me.
- Lev Borodovsky, “What to Make of Softening Inflation,” The Wall Street Journal, 3 July 2017, B12.
- Jeffrey Sparshott, “Jobs Grow but Wages Stay Stuck,” The Wall Street Journal, 8-9 Juy 2017. A1.