MNI INTERVIEW: US Infl May Be Lower Than Thought -Fed Economst

--Mismeasured Impact of IT Boom Suggests Productivity Growth Underestimated

--If So, FOMC Policy May Be Less Accommodative Than Thought, Philly Fed

Economist Tells MNI 

By Jean Yung

     WASHINGTON (MNI) - U.S. inflation could be even lower than government

figures suggest, if official price-level gauges fail to account for the full

impact of recent technological innovation on productivity and output, a Federal

Reserve economist told MNI in an exclusive interview. 

     Research by Leonard Nakamura of the Philadelphia Fed suggests that

productivity growth has been underestimated in recent years because improvements

in IT are massively understated in official data. That would mean inflation is

overestimated -- at a time when the Fed is already struggling to explain why

inflation has been softer than expected.

     "If in fact there's all this progress being made, then maybe the true rate

of inflation is negative. Maybe we (at the Fed) think we're being very

supportive to the economy by having a super low interest rate -- but maybe it's

not so low," Nakamura said.  

     That would be sobering news for officials who worry that persistently low

inflation could leave the central bank with less room to maneuver should another

recession hit. On the other hand, it would allay some of the Fed's worst fears

-- that a prolonged productivity slump will drag the U.S. economy into an

extended period of slow growth. 

     A number of top Fed officials have cited economist Robert Gordon's work

arguing that the slowdown in U.S. GDP growth since 2004 is likely to be

permanent as new scientific inventions can't match the disruptive power of past

breakthroughs such as electricity and the internal combustion engine. 

     But Nakamura is among a different group of economists making the case for a

more optimistic outlook and his thinking has in recent months filtered into that

of Philadelphia Fed President Pat Harker's public remarks.  

     Nakamura says the key question in his research is the following: If

economists agree that knowledge and information benefits consumers tremendously,

and we live in an era where so much of it comes at little to no cost via the

Internet, how is that utility gained by consumers accounted for? 

     "My argument is we're better off in a gazillion different ways than we were

30 or 40 years ago, and the majority of these ways we don't know how to count,"

Nakamura said. 

     In a working paper he co-authored with Jon Samuels and Rachel Soloveichik

of the U.S. Bureau of Economic Analysis, Nakamura developed an experimental

methodology that values "free" digital content such as advertising-supported

Google search or freemium smartphone games from the production side, rather than

the expenditure side. 

     In our current GDP framework, the value of some of these products is

excluded altogether because there is no directly measured transaction between

the producers and users of free digital content. That leads to a significant

downward bias in official estimates of growth and productivity, they argue.

     The economists found that real GDP growth would be a tenth of a percentage

point faster between 2005 and 2015, and the personal consumption expenditure and

core PCE deflators would have risen a tenth slower using their measurement

approach. 

     "We find that including advertising-supported media and marketing-supported

information in final output has a substantive impact on measured real GDP growth

and (total factor productivity) growth," they said. 

     That supports the finding of a study by Erik Brynjolfsson of MIT that takes

a different approach. If one asks a consumer how much you would need to pay him

to stay off Facebook for a month, the answer isn't equal to the price of using

the social media website. 

     "When somebody makes a statement like the average citizen in the U.S. is no

better off today than they were 20 years ago because inflation has wiped out all

the gains from their paychecks, they're not counting all the things that I'm

talking about," Nakamura said. 

     "We are, in my view, a lot more productive in terms of what really matters

-- how much we can enjoy life with a smartphone, a better education, or

streaming media. But it's not being picked up in our data."

     As an outside expert advising the Bureau of Labor Statistics, Nakamura said

he is also lobbying the agency to consider applying quality adjustments to past

prices reports. Currently BLS analysts conduct a monthly set of surveys and

those figures are never revised with the exception of changes to seasonal

adjustments. 

     "What I and others are pushing for is for the capability to look back and

ask the question, did we get that wrong? We're pushing them to widen their scope

of analysis," he said.  

     Look at aspirin for example. Its production process is no different than

decades ago, yet studies have shown over the years that its benefits extend

beyond migraines. It can help prevent a heart attack or stroke and even reduce

the risk of some cancers. 

     So the average consumer is getting more out of aspirin but the price has

not changed. Should BLS call that disinflation? 

     Nakamura said economists are still perplexed about how to best measure such

a decrease in inflation, though he and others are convinced that economists

ought to think of inflation as lower than it is. 

     The upshot for Fed policy now might be that "we should be less worried by a

low unemployment rate than we otherwise might be," Nakamura said. 

     And over the long run, if indeed inflation is mismeasured more so than in

the past, "it's possible we ought to be thinking about raising our inflation

target," he said. 

     "Of course we'd have to get up to 2% before raising it to 3%," he added,

"but in the long run one of the things that my research and those of others are

pointing to is we might want to raise the inflation target to compensate for the

mismeasurement, because it's unlikely that we'd correct that quickly." 

--MNI Washington Bureau; +1 202-371-2121; email: jean.yung@marketnews.com

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