So, it sounds like I need to add a bit about the basic premise of the speech and the paper. And, the forums ate my first post, so if I seem a little pissed, I am, but at the forums software.
<a href="http://www.federalreserve.gov/newsevents/speech/bernanke20080609a.htm">First, here is a link to Ben's speech</a>. A part that I think is significant...
<em>
Empirical work on inflation, including much of the classic work on Phillips curves, has generally treated changes in commodity prices as an exogenous influence on the inflation process, driven by market-specific factors such as weather conditions or geopolitical developments. By contrast, some analysts emphasize the endogeneity of commodity prices to broad macroeconomic and monetary developments such as expected growth, expected inflation, interest rates, and currency movements. Of course, in reality, commodity prices are influenced by both market-specific and aggregate factors. Market-specific influences are evident in the significant differences in price behavior across individual commodities, which often can be traced to idiosyncratic supply and demand factors. Aggregate influences are suggested by the fact that the prices of several major classes of commodities, including energy, metals, and grains, have all shown broad-based gains in recent years. In particular, it seems clear that commodity prices have been importantly influenced by secular global trends affecting the conditions of demand and supply for raw materials. We have seen rapid growth in the worldwide demand for raw materials, which in turn is largely the result of sustained global growth--particularly resources-intensive growth in emerging market economies.1 And factors including inadequate investment, long lags in the development of new capacity, and underlying resource constraints have caused the supplies of a number of important commodity classes, including energy and metals, to lag global demand. These problems have been exacerbated to some extent by a systematic underprediction of demand and overprediction of productive capacity for a number of key commodities, notably oil. Further analysis of the range of aggregate and idiosyncratic determinants of commodity prices would be fruitful.
I have only mentioned a few of the issues raised by commodity price behavior for inflation and monetary policy. Here are a few other questions that researchers could usefully address: First, how should monetary policy deal with increases in commodity prices that are not only large but potentially persistent? Second, does the link between global growth and commodity prices imply a role for global slack, along with domestic slack, in the Phillips curve? Finally, what information about the broader economy is contained in commodity prices? For example, what signal should we take from recent changes in commodity prices about the strength of global demand or about expectations of future growth and inflation?</em>
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1) What is a Phillips curve analysis? And do I need to know what it is in order to understand the point? If not, then I don?t really care what it is.</blockquote>
<a href="http://www.econlib.org/LIBRARY/Enc/PhillipsCurve.html">Yes, you need to understand the idea of the Phillips curve</a>.
<em>
The Phillips curve represents the relationship between the rate of inflation and the unemployment rate. Although several people had made similar observations before him, A. W. H. Phillips published a study in 1958 that represented a milestone in the development of macroeconomics. Phillips discovered that there was a consistent inverse, or negative, relationship between the rate of wage inflation and the rate of unemployment in the United Kingdom from 1861 to 1957. When unemployment was high, wages increased slowly; when unemployment was low, wages rose rapidly. The only important exception was during the period of volatile inflation between the two world wars.
In Phillips's analysis, when the unemployment rate was low, the labor market was tight and employers had to offer higher wages to attract scarce labor. At higher rates of unemployment there was less pressure to increase wages. Phillips's "curve" represented the average relationship between unemployment and wage behavior over the business cycle. It showed the rate of wage inflation that would result if a particular level of unemployment persisted for some time. Significantly, however, the relationship between wages and unemployment changed over the course of the business cycle. When the economy was expanding, firms would raise wages faster than "normal" for a given level of unemployment; when the economy was contracting, they would raise wages more slowly than "normal."
Economists soon estimated Phillips curves for most developed economies. Because the prices a company charges are closely connected to the wages it pays, economists also frequently used Phillips curves to relate general price inflation (as opposed to wage inflation) to unemployment rates. Chart 1 shows a typical Phillips curve fitted to data for the United States from 1961 to 1969. The individual observations appear to lie closely along the fitted curve, indicating that the cyclical behavior of inflation and unemployment is similar to the average behavior. That is, the relationship between inflation and unemployment does not seem to change much over the course of the business cycle. </em>
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2) Potential output? What is that? Best case scenario? If so, what idiot is even paying attention to the best case scenario when in reality that rarely happens?</blockquote>
Potential output is the estimate of what the actual output will be. It isn't best case or worst case, but if something like rising commodity prices were not factored it could make the gap larger.
<blockquote>3) What does the output gap, which appears to me to be the difference between what actually happened and what could have happened, have to do with inflation? I ask that because I really haven?t the foggiest idea.</blockquote>
You are right, it is the difference between the actual and potential output. Output is in real terms, so if the inflation data is not in real time the potential output could be lower or higher than the actual out, and therefore increasing the gap between the two.
What Ben was speaking about was having better and more real time data to use, and asks what could be used to improve the data, especially for the rising commodity costs and what has a greater effect on them; domestically or globally. What Dr. Thoma was pointing out was the paper that has an amazingly proven track record for real time data. Ben seems to be an agent of change for the Fed, and IMO it sounds like he would like to implement something along the lines of what was discussed in the paper. Per Ben's speech...
<em>The growing literature on learning in macroeconomic models appears to be a useful vehicle to address many of these issues.10 In a traditional model with rational expectations, a fixed economic structure, and stable policy objectives, there is no role for learning by the public. In such a model, there is generally a unique long-run equilibrium inflation rate which is fully anticipated; in particular, the public makes no inferences based on central bankers' words or deeds. But in fact, the public has only incomplete information about both the economy and policymakers' objectives, which themselves may change over time. Allowing for the possibility of learning by the public is more realistic and tends to generate more reasonable conclusions about how inflation expectations change and, in particular, about how they can be influenced by monetary policy actions and communications.
The second category of questions involves the channels through which inflation expectations affect actual inflation. Is the primary linkage from inflation expectations to wage bargains, or are other channels important? One somewhat puzzling finding comes from a survey of business pricing decisions conducted by Blinder, Canetti, Lebow, and Rudd, in which only a small share of respondents claimed that expected aggregate inflation affected their pricing at all.11 How do we reconcile this result with our strong presumption that expectations are of central importance for explaining inflation? Perhaps expectations affect actual inflation through some channel that is relatively indirect. The growing literature on disaggregated price setting may be able to shed some light on this question.12
Finally, a large set of questions revolve around how the central bank can best monitor the public's inflation expectations. Many measures of expected inflation exist, including expectations taken from surveys of households, forecasts by professional economists, and information extracted from markets for inflation-indexed securities. Unfortunately, only very limited information is available on expectations of price-setters themselves, namely businesses. Which of these agents' expectations are most important for inflation dynamics, and how can central bankers best extract the relevant information from the various available measures? </em>
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You posted the chart. I?ve seen that chart, or something like it, before. What about it? So what? Is it different than other ?we are going to have a recession? charts and I?m just not paying close enough attention? That is highly possible.
The dudes have some ingredients. I got that. </blockquote>
That chart is the results of their ingredients in a real time factor predicting a recession. It has been amazingly correct, but still needs to be adjusted and tested with other economies.
