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Financial economics

Started by chrisild, February 22, 2012, 01:13:59 AM

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While Der Spiegel and Dombrovskis raise valid points in a responsible way, the official report on inflation contains another basic mistake. Imagine a respected doctor saying: It is healthy to live in a fridge. The higher a fever the sicker you are, so the lower your temperature, the healthier you are." Wouldn't really increase your trust in him, would it? So how about a civil servant who thinks that the lower inflation is, the better?

1. What would you say to someone who compares the price of a 1950 Volkswagen Beetle to a version produced this year? Right. Different products. Looks similar, same name, no comparison.

2. Inflation is not measured with the price of all goods, but with a basket. Statisticians are not great on deciding what to put in the basket (smart phones, for instance) and what to throw out (e.g. carpet beaters).

The combined effect of the above is that inflation is systematically reported 1 (says the ECB) to 2 (says the Fed) percentage points too high. In other words, Sweden was almost surely deflating and the other two were close. The point about deflation is that while economists have a number of policies in their toolkit to combat high inflation, they don't have a single one that seems even to have an influence on deflation (there is actually a proposal to throw banknotes out of helicopters to combat deflation!) Moreover, deflation doesn't repair itself if left alone. In other words, Sweden was not the best performer in terms of price stability, but the worst. Its economy is in danger of stalling.

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