Here we go again. I’ve written something to that effect several times over the past couple of years, what with the 2011 debt ceiling debate, the 2012 fiscal cliff, and now this. Governmental dysfunction has been normalized.

The phrase that comes to mind is “defining deviancy down,” from a 1993 paper by Daniel Patrick Moynihan, one of the great statesmen of American politics. The idea is similar to the boiled frog theory I described last month: with every ratchet down in behavior, the new low becomes somehow normal, and any subsequent changes are perceived as being less bad (compared with the new “normal”) than they would have been otherwise. Another way to describe it is a behavioral downward spiral—that is, behavior that formerly would have been thought absolutely disgraceful is now seen as somewhat embarrassing.

As discussed in the previous installment in this series, adjustments are at the core of the debate about inflation, but another way to look at the problem is to consider exactly what’s being measured here. Substitution, of one type of good for another, is a clear case of something being different. What about when you’re talking about the same item, though—say a TV set? Is an HDTV with a flat screen and built-in Internet access the same as an old tube TV without a remote?

These adjustments—for quality, utility, or both—are known in the trade as hedonic adjustments. Again, Shadowstats leads the charge against the current adjustment method, using government-mandated gasoline additives as the poster child for fraudulent adjustments. In its response, the Bureau of Labor Statistics outlines its methodology and gives two examples: a candy bar, which is selling for the same price as before but now weighs half an ounce less, and a TV, which is now available only as an HD model at twice the price. Is an adjustment necessary? If yes, how should it be calculated?

I have to be honest: I’ve been putting off writing about this for the past couple of days, for both good and bad reasons. One good reason is that, really, there hasn’t been much news. Congress is playing games, everyone is shouting at each other, and nothing is getting done. The other good reason is that there’s not much we can do to prepare, given the level of uncertainty that prevails. No news, no action items, no need to comment.

The bad reason I have for putting this off is that, quite frankly, it’s depressing. We’ve been through this before, in both 2011 and 2012, and the fact that we’re going through it once again is just ridiculous. Be that as it may, though, here we are, so let’s deal with it.

“I gather, young man, that you wish to be a Member of Parliament. The first lesson that you must learn is, when I call for statistics about the rate of infant mortality, what I want is proof that fewer babies died when I was Prime Minister than when anyone else was Prime Minister. That is a political statistic.” — Sir Winston Churchill

There are three significant criticisms of the Consumer Price Index (CPI) methodology. The first is that the substitution of items in the basket of goods is not appropriate (the “hamburger versus steak” argument). The second is how to account for changes in the quality of goods sold. The third is the use of rental equivalence to measure housing costs and their contribution to the CPI.

“Facts are stubborn things, but statistics are more pliable.” — Mark Twain

Economic statistics are backward looking, not forward; in that sense, they always reflect the past. Moreover, given data collection time lapses, costs, and other issues, the data is always incomplete and more or less out of date. Finally, in a vast and heterogeneous economy, the applicability of one statistic to everyone is impossible. These are the general issues that any statistical service wrestles with. No figures are going to be perfect. At the same time, it’s important to know where the numbers you depend on come from, and what their strengths and weaknesses are.

I wrote about inflation risk at length back in January of this year. Although inflation wasn’t a concern at the time, I noted that we would have to be watchful when three things happened: a decrease in the unemployment rate, a resumption of bank lending/consumer borrowing, and faster growth in GDP. All three of these are happening now, so it’s time for another look.

Another reason to revisit inflation is the Fed. One of the arguments for maintaining the Fed’s stimulus program, albeit one that hasn’t gotten a lot of play, is that inflation is still well within a reasonable range. With the stimulus set to continue, we can reasonably expect inflation to continue at current levels, and quite possibly to increase. This is actually a goal of the Fed’s—and it usually gets what it wants.

As I mentioned yesterday, the countdown to fiscal meltdown is back on. Washington, DC, has once again formed a circular firing squad, busily loading weapons and aiming across the circle, oblivious to the fact that the guy on the other side is doing the same thing.

The past week has been interesting, with lots of developments. Rather than trying to cover just one, I thought we should look at several of the most important.

You may have noticed a relatively new feature on the blog, “Ask Brad” (on the right side of the page). The first question that came in was a good one from Tim Bourdon, who wrote: “You mentioned that we are in better shape now than five years ago, but Europe is still in a much riskier position. If their market falls apart, are we strong enough to withstand that?”

This is a good question because it cuts to the core of how much risk has actually been reduced, post-financial crisis. The real danger, in 2008 and 2009, was that the financial markets around the world would seize up as banks refused to lend to each other. That would have led to a cascading series of defaults as banks, unable to get their money back from where they had lent it, would in turn be unable to pay their creditors. A downward spiral would result, bringing down the whole system. Europe was a key part of this, and it is this risk that I highlighted in my earlier post.

To the surprise of many, the Federal Reserve decided yesterday to continue its stimulus program at the current levels, buying $85 billion of Treasury and mortgage-backed bonds per month. Not only did it opt to continue buying at current levels, but Chairman Bernanke repeatedly went out of his way to note, in the press conference afterward, that the Fed reserves the right to continue stimulus, no matter what the various metrics it had previously used as targets do. He seemed to be walking back much of the guidance he had previously provided, trying to make the Fed harder for the market to predict. With this action, he succeeded.