Friday, July 10, 2009

I'm Impressed with the Fit...

I posted the below update directly to yesterday's post on Capacity Utilization vs. CPI, but as it was late in the day, had already moved down the blog, and involved the questioning of the validity of one of my beautiful charts, here it is again with a bit of additional analysis.

Scott Grannis of Calafia Beach Pundit apparently reads my blog, which is cool (for those that missed my earlier post, he is my favorite blogger to disagree with). He posted on the same topic of capacity utilization vs. CPI (bold mine). Here is an excerpt:

As a counterpart to my interpretation of events, I suggest you have a look at a similar post on EconompicData which has a chart that paints a very different picture than my chart. He argues that the change in capacity utilization has always been a good predictor (by 6 months) of inflation. I'm not all that impressed by the fit of the two lines on his chart (sometimes they move together, and sometimes they don't), and I don't think there is a logical reason to expect a strong fit in the first place.
Here is the chart from yesterday which is referring to...

Before I defend the chart, I must defend myself. I never said capacity utilization has ALWAYS been a good predictor of CPI (that would be foolish). The only thing I know that "always" follows something is my interrupting someone after I've had a few beers. I think "generally" would be the term I would have used.

But more important to the credibility of EconomPic is that Scott is "not impressed" by the "two lines" in my chart. To me the relationship seems strong, but let's see what the math shows.

Drum roll please.....

The monthly "lines" in the chart above have a correlation of 0.533 from July 1982 - November 2008 (the last date I have for CPI due to the 6 month lag). Why July 1982? Because I like to make my numbers more impressive (the correlation from June 1982 was "only" 0.504 and from August was "only" 0.522).

And over 1, 5, 10, 20, and 30 years? Well, here's the chart...

Our back and forth reminds me of an article I just read over at, Yes, I Suck: Self-Help Through Negative Thinking. In the article they detail a study, which I feel is at the heart of our argument and the need for Scott to say that "he isn't impressed by the lines on the chart" and my need to update not only my original post, but add this one as well.

The study's authors, Joanne Wood and John Lee of the University of Waterloo and Elaine Perunovic of the University of New Brunswick, begin with a common-sense proposition: when people hear something they don't believe, they are not only often skeptical but adhere even more strongly to their original position. A great deal of psychological research has shown this, but you need look no further than any late-night bar debate you've had with friends: when someone asserts that Sarah Palin is brilliant, or that the Yankees are the best team in baseball, or that Michael Jackson was not a freak, others not only argue the opposing position, but do so with more conviction than they actually hold. We are an argumentative species.
But, can anyone reasonably argue, whether or not they like the data or analysis, that this isn't at least a semi-strong correlation?

I'm guessing Scott may have something to say.

Source: Federal Reserve, BLS


  1. Jake,

    I'm the type that doesn't mind being wrong and loud about it. That may seem like a negative, but CONfidence sells.

    Speaking of selling, more and more it seems that selling is all that matters in the new (e)CONomy. Even the eCONomists are in on the deal. Why? Because the debts can't and won't be paid - at least not as originally agreed.

    To big to fail applies to way too much of our debt.

  2. Jake,

    Regarding the CPI/CU chart, I think it has merit. But it is interesting that the CU yoy change is based on a decrease from a baseline. The CPI is based (until recently) on an yoy increase from a baseline although at a decreased rate of increase.

  3. mab-

    i like 'eCONomist'

    i found it interesting as well. basically if the CU changes, then the level of YoY CPI changes. once the CU settles into the "new normal", then CPI seems to stay at the "new level".

    investment wise, this seems relevant for forecasting the break-even inflation rate for TIPS if you have a projection for how CU will look. i personally don't.


  4. i like 'eCONomist'

    Most have become shills for the financial industry. Those that aren't shills are marginalized by the MSM.

    Just look at the bias:

    Roubini is "Dr. Doom" while none of the wall st. eCONomists are "Dr. Polyannas" or "Dr. always wrongs".

    FWIW, I think the TIPS market has it right for the next decade - low real returns and low inflation. Actually, over the next few years, the TIPS market looks optimistic to me. We've earned a deflatioary bust, but Bernanke appears to be very serious in "making sure it doesn't happen here".