Pseudoscience

As I read back through my last few posts, I begin to understand more how Economics is more of an art than ever. The past six months has seen me begin to work on several projects that involve data science and will result in writing a few technical papers. In contrast I spend a fair amount of free time reading about economics and investments. They have become similar lately in both concern about the Federal Reserve and in purpose for writing.

The work around investments is close to what philosophy is — there are some generally accepted truths and many different derivative avenues from those. Economics has turned completely away from examining data and towards opinion and personalities. That is nearly what an art form is about.

In writing the technical articles, I have come to appreciate what is becoming accepted — “science is hard”. In reading economics, I have also come to appreciate that opinion is all that matters.

I listen to Bloomberg radio on my drive to work each morning. At least daily, a guest is asked their opinion about the timing of a Fed rate hike. Less than weekly does a guest discuss the consequences of a rate hike. It seems to me that is backwards — if we understand the consequences of an event, then whether to cause the event can be judged.

There is no one who thinks an increase in the Federal Funds rate will cause the trade weighted value of the dollar to fall. There are some who think it will not change because the rate increase is so well known. Most expect the value of the dollar to rise. Some think this will have little impact. Most understand this will increase the effects of disinflation (the difference between disinflation and deflation is the sign in front of the number). Thus, the only reason to raise rates is to curb inflation.

The July CPI was released this week. The one year inflation rate is 0.17%. The ten year annual inflation rate is 2.02%. These numbers tell me that inflation is not a problem and long term inflation is continuing to decrease.

The problem arises when we include information about the market. In five years, the market expects annual inflation to be 1.60%. This is a problem because this is not data — it is opinion. If we include this number in our analysis and say inflation looks well contained even five years out, we are no longer using data to make a judgment. Instead we are basing our judgment on the opinion of others. Discard this number and let’s go back to the ten year rate.

One year ago, the annual ten year inflation rate was 2.32%. Now it has fallen to 2.02%. That trend is very clearly lower. The current one year rate is well below the current ten year rate. That will mathematically keep pushing the ten year annual rate lower.

The next step would be to examine the possibility of this changing. With only one input, this is straight forward to do. The one year rate needs to rise above the annual ten year rate. In order for that to happen, there needs to be a sustained increase in those factors that enter the inflation numbers. Yet, commodity prices are heading lower, wages are low and stagnant, consumer demand is slowing (especially in the retail sales numbers), government consumption is slowing dramatically, and business investment has not changed in years. None of these items are showing any indications of leading to increases in the CPI.

This analysis and thought session has given me some indications for what to watch in late 2015 and beyond. The 2015 watch list is nearing the end of its interest and I have to wonder what is next. I’ll start working on the data series list that could provide indications of a change in the rate of inflation.

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Author: dmcnic

Educated as an economist, I now work as an Analytical Professional for a manufacturing firm. I have have a second job as a part-time lecturer at the University of Washington in Bothell. While all baseball interests me, the Mariners are my home town team. Married with one dog.

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