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Repeats Story Initially Transmitted at 22:03 GMT Nov 27/17:03 EST Nov 27
--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