Two example recently reminded me about a thought I have been having for a while: Sometimes it feels that most of macro analysis is really about choosing the right transformation. I will illustrate it in three posts. First, a post about euro zone energy inflation.
For most of the 2022 there was a discussion about whether the spike in euro zone inflation is driven solely by surge in energy prices, or whether it is more broad-based. (Of course, the truth is somewhere in between those two…). One side was pointing out that half of the inflation was accounted for by energy component directly:
Of course the other side countered that also the other non-energy components are elevated and that inflation is very broad-based:
To which the first side countered that it is because of
energy – i.e. pass through. And here comes the power of choice of transformation.
How do you make the case that energy drives the rest of the basket, or that it
does not? Enter a chart from Riccardo Trezzi (tweet has been deleted since):
Looks like energy CPI goes up and down all the time without causing any large spike in overall CPI, right? Implying that the current spike in energy should not be the cause for spike in overall inflation, given that it is not that abnormal, right? Well, look again, this time using the level of both series rather than the y/y growth rate:
This paints completely different picture: while there were
surges in energy prices before, the current surge is simple in a league of its
own (and there even isn’t another professional league…). Energy prices have
surged by almost 100% in period of 1,5 year, with previous largest surge in
similar period was more like 25%.
My point is not to settle the debate. My point is to show
how the simple act of choice of transformation wields immense power in
macroeconomic analysis. As I always say, good statistician./macroeconomist can show
anything with any dataset…
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