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THE Federal Reserve looks at a lot of different data points when considering the economy's rate of inflation, but its preferred measure is a core measure, which strips out the volatile energy and food components. Other central banks, including the European Central Bank, prefer to focus on headline inflation. This is understandable; people pay for the volatile components just as they pay for the core components. But making policy around headline numbers may add to instability in some cases.

In the summer of 2008, for instance, rising oil prices caused headline consumer prices in America to soar. At the same time, however, core inflation was flat, and inflation expectations were actually falling. Had the Fed tightened policy at this time, it would have undermined the American economy just as the financial crisis was developing—essentially repeating the monetary errors of 1929. Happily, the Fed's focus on core inflation prevented this. Had the Fed focused more on inflation expectations, it would have acted more aggressively still, sparing the economy some of the pain of the second half collapse.

I mention this because, as I noted, the ECB focuses on headline inflation and European headline inflation is rising. In January, headline producer prices jumped 1.5% from the previous month and 6.1% from the previous year. That was well ahead of economist expectations. Energy costs were the main factor; headline prices rose twice as much as core prices, and the increase in core was largely due to producers passing on their higher energy costs to consumers. This trend is sure to continue in the short-term. In the month of February, a barrel of Brent crude oil rose in price by about $15. And the hawkish, headline-oriented ECB may well respond by tightening policy.

But this would be a mistake. For an inflation spiral to begin, it's not sufficient for firms to pass on energy costs to customers. Those customers must then demand higher wages, which are themselves higher firm costs. But most European workers are in no shape to bargain for wage increases. The euro zone unemployment rate is currently at 9.9%, essentially unchanged from a year ago.

The problem for Europe is that its core economy, and the dominant voice in euro zone monetary policy, is Germany. Germany's unemployment rate is just 6.5%, and it's down from 7.3% a year ago. Wage pressures may well be surfacing in the German economy. And that will make some ECB officials very nervous.

It shouldn't. Tightening in response to rising German wages would be doubly harmful to struggling peripheral countries. It would make an inappropriately harsh (for them) monetary policy harsher still. And by preventing any wage increase in Germany, it would undermine a process of internal euro-zone rebalancing that really needs to take place.

But I don't expect these concerns to get much of a hearing in Frankfurt. And I suspect that the people making similar arguments in London may also be disregarded.

AN INTERESTING story from FT beyondbrics:

The wave of Chinese money that has crashed through the markets for fine wine, art and antiques is now flooding into the altogether sleepier world of stamp collecting.

At an auction in Hong Kong this week, a rare block of four stamps from the Cultural Revolution sold for HK$8,970,000 (US$1.1m) – an all-time record for a Chinese stamp or multiple. Including a 15 per cent buyer’s fee, the anonymous buyer paid over US$1.3m for the stamps.

Here's a fun sentence:

The 3,000-lot Hong Kong auction has sent ripples of excitement through the stamp collecting world because it raised a total of HK$98.7m (US$12.6m), almost double the pre-sale estimate of HK$50m.

Stamp collectors haven't been this excited since, I don't know, some previous stamp auction. The guy who runs the firm that handled this particular sale is quoted in the piece, and he attributes the soaring price of stamps to Chinese growth. It's of a piece with the rise in wine prices, which is due to a soaring Chinese interest in wine-drinking ("though some grumble that wealthy mainlanders have been known to commit the ultimate faux pas of smoking cigarettes or chewing gum at wine tasting events").

But here's the thing. When prices for consumption goods soar consumption growth falls, which limits further increses, OR rising prices feed back into wage increases and generate broader inflation. That's not an ideal situation for the Chinese economy, but it would have some positive effect on rebalancing, it's an easily observable process, and it's curable with an expectations-adjusting period of monetary tightening and slower growth (or recession). But when prices for investment goods soar, demand for investment goods may increase as new buyers speculate that price rises will continue. The result is a bubble, and the impact can be extremely pernicious. In the present, serious misallocations of capital can result. In the future, the inevitable crash may lead to a deeper, more painful downturn.

I know China is trying to rein in exuberant investors cautiously to avoid a sudden crash. But the more these kinds of stories appear, the more one suspects they may be acting too slowly.

TODAY'S recommended economics writing:

• Globalization and the expanding moral circle (Marginal Revolution)

• Working on the railroad (Slate)

• Obama trade plans are stalled (New York Times)

• Annals of white-collar crime (Felix Salmon)

• IMF economists on current account imbalances (Real Time Economics)

NOT long ago, I had occasion to visit a small, independent hardware store in the Washington neighbourhood I used to call home. While checking out, I noticed a flyer taped to the counter, calling on local residents to oppose the planned opening of four Wal-Mart stores around Washington. I first found this perplexing; the store is less than a mile from a massive Home Depot (which I'd patronised earlier in the day); if big-box retail was going to kill the store, it would be dead already. But after reading an anti-Wal-Mart missive from another small business owner, I've been wondering: what message do these guys think they're sending?

I mean, can you imagine a television station running ads asking you to complain to your government about the existence of other channels? Or if every brand of peanut butter on the shelf carried a sticker demanding that other brands of peanut butter be removed?

As a customer at the hardware store, I have to say I was a little insulted. The message couldn't be more clear—as a business we're concerned that your decision to seek a better selection of goods at lower prices will force us to close. Actually, I suppose it's worse than that—we think you, enlightened customer, appreciate the benefits of an uncompetitive business enough to deny others the option to buy from a store with more attractive goods and prices than our own. Honestly, what sort of patron is moved to action by the call to kill off the competition?

Where Wal-Mart is concerned, complainers typically argue that its practices are somehow unfair. Here's Andy Shallal, a local restaurateur who somehow manages to stay in business despite the presence of other nearby food vendors, some of which sell meals at shockingly low prices:

Some would reason that our most vulnerable neighborhoods, where the stores are planned, are desperately underserved.

Others argue that low prices are necessary for low-income families.

Yes, we do need economic development. But Walmart's traditional poverty-level jobs are not the solution. They will continue to depress wages and labor standards and deepen the ranks of the working poor.

Community leaders and local business owners have started to organize to stop Walmart from coming to D.C. These stakeholders are not lulled by Walmart's newly-polished image.

Rather than giving in to Walmart's assault, we need a sustainable economy: innovative local businesses, better tax incentives, improved infrastructure and a more prepared work force.

Local, independent businesses give a neighborhood character. And they create more local jobs, pay more taxes and keep more money in the community.

Nothing like a rich man arguing that new jobs aren't likely to be good enough for workers who are currently unemployed. Here's the truth. If Washington's poor are able to obtain needed household goods at lower prices, they'll have more money left over to buy other products. Those products could include a coffee at Mr Shallal's business, or healthier food, or a training course that will enable them to find a better job. What's more, Wal-Mart can only pay rock-bottom wages in Washington if there's surplus labour. And if there's surplus labour, well, that may be because businessmen like Mr Shallal are so anxious to shut potential employers out of the city of Washington.

IT PAYS to pick your drinking buddies carefully. It's nice if they enjoy a pint as much as you do. But if they hold their liquor too well, you may wake up regretting trying to keep up with them.

In the years before the financial crisis, Australia's economy set a hard, fast pace for the rest of the Anglo-Saxon world. Its house prices rose faster than Britain's or America's (although Ireland's outstripped them all) and its current-account deficit gaped wider for longer. But its economy proved strong-livered. House prices fell from March 2008 to March 2009 (as measured by the weighted average of the eight state capitals), then resumed their rise. In the year to the first quarter of 2010, they jumped by 18.8%!

This week in The Economist we will publish our quarterly index of house prices around the world. Australia's homes are the most overvalued in the index. The ratio of prices to rents in the country is fully 56% above its long-run average (see chart).

The question now is whether Australia's hair of the dog treatment will work, or whether the property market will suffer another bite. Yesterday the RP Data-Rismark index showed prices rising by just 1.2% in the year to January. Compared with the previous month, they fell by 1.6%.

Many economists in Australia argue that the country's lofty property prices are justfied by a variety of fundamentals. Immigration has swelled the population, and zoning regulations, infrastructure charges and the like have imposed artificial constraints on the availability of land. (I must confess that I smile when I read about land scarcity in Australia. I am writing this from the 60th floor of an office tower in one of the most crowded places in the world. If Australia were as densely populated as Hong Kong, it could accommodate all of the world's people seven times over.)

These fundamentals no doubt matter. But one of the virtues of a price-to-rent ratio is that it takes them into account. If immigration is putting upward pressure on house prices, it should put upward pressure on rents too. And if developers can't build homes, they can't build rental homes either. Those factors may justify high prices. They don't justify high price-to-rent ratios.

The difficulty in using these ratios (or any other) as a measure of overvaluation is knowing what the ratio should be—what counts as an equilibrium? In our house-price index we take a simple historical average from 1975 to 2010. But perhaps something has changed in Australia in that time that now warrants a higher ratio. The chart above is certainly suggestive of some kind of structural break after 2000*. If you compare today's price-to-rent ratio with its average over the past ten years, it is overvalued by 12%, not 56%. Compared with its five-year average, it is overvalued by just 3%. 

If things are different now, why might that be? Low interest rates and financial liberalisation is one answer. But Ireland, Britain and America enjoyed those too. What marks Australia out of course is its extraordinary resource boom. The country's terms of trade (the price it can fetch for its exports, relative to the price it pays for its imports) is at its highest since the 1950s (see chart). So perhaps lucrative exports of iron and coal justify rich valuations for bricks and mortar?

In a recent paper, Patrizia Tumbarello and Shengzu Wang of the IMF show that a 10% improvement in the terms of trade tends to lift Australian property prices by about 5%. What they don't investigate is whether it raises the ratio of prices to rents. I think it's at least possible that a resource boom affects asset prices, like houses, differently from the price of a service, like rental accommodation. The bright prospects in mining and minerals will attract capital inflows into the resource sector, which might bid up the price of other assets in the economy. And in buying a house, the average Australian might see a way to crystallise the future income he expects will trickle down to him from the commodities boom.

Thanks to the improvement in the terms of trade, the average Australian's expected lifetime wealth has increased. In theory, he should be able to enjoy some of that windfall in the present, by borrowing against his future gains. But his bank might prefer it if he borrows to buy a concrete, collaterisable house instead. That way, he can either withdraw housing equity, if he wants to consume his future earnings, or accumulate it, if he wants to save them.

It's a bit like lining your stomach, before you go out drinking.

*Only suggestive. Charts for Ireland before the crisis looked very similar. See Fig III.4.

WHITE HOUSE officials announced last week that we need not worry about Social Security, for now anyway. They reckon it should not be included in the upcoming discussions on how to reduce the deficit. They figure it’s a future problem, so it has no place in a current deficit reduction plan. But entitlements make up almost the entire structural debt problem. That’s far more dangerous than current deficits from discretionary spending. Leaving Social Security off the table means that reform of the programme probably won't happen any time soon. White House Budget Director Jacob Lew and the deputy director of President Barack Obama’s National Economic Council, Jason Furman, explain:

In a Feb. 22 editorial in USA Today, Lew said the retirement program’s trust fund will have adequate resources to pay full benefits to retirees for the next 26 years, that the nation’s debt “problem is not Social Security” and that strengthening the program should be handled separately.

Speaking to NDN, a Democratic-leaning advocacy group, Furman said talk of a Social Security overhaul “is not one you care about” if “you are worried about our long-run fiscal future.” He said the program is “the bedrock of retirement security” and solvent for another 26 years, until 2037.

I am not sure if Messrs Lew and Furman genuinely believe this or if they’re innumerate. It is akin to saying that since I am working now, earning money, and have a new infant who will probably become a millionaire someday and take care of me, I don’t need to save for retirement. It is true Social Security is not currently adding to the deficit. But it is projected to run an actuarial deficit by 2037. Does it threaten to make the American government insolvent? No, but without reform it does add to the structural deficit. If no action is taken, obligations will run to 3.3% of taxable payroll or 1.2% of GDP. Perhaps not a fiscal crisis, but a non-trival amount of spending. These assumptions look far into the future so there is a fair bit of uncertainty, but that's no reason to feel better. They assume that the American economy will experience the same rates of growth it has in the past. If the American birth rate continues to decline the figures will be even larger.

Restoring long-run solvency will cost money, either in the form of tax increases or benefit cuts, or some combination of the two. The sooner action is taken, the smaller benefit cuts and tax increases must be. Politicians who claim that Social Security is not a problem are really saying they have no qualms about sticking future retirees and taxpayers with an enormous bill and additional retirement insecurity. The alternative is to simply ask everyone to start paying a little more now.

It is true that Medicare is a bigger fiscal threat and harder to solve, but that does not mean Social Security is not a problem. Ignoring it is like not treating a broken leg because the patient already has cancer. As former budget director Peter Orszag points out, fixing Social Security sends a strong signal to bond markets that America is serious about addressing its long-run debt. What sort of message does it send that America lacks the fiscal discipline to solve even relatively easy problems?

In addition to the addition cost delay passes to future taxpayers, a refusal to change the programme now also leaves young people with uncertainty regarding a large part of their retirement income. I often hear people say, “Social Security won’t be there for me”. That’s probably not true; the programme will continue in some form. But until credible reform occurs, it’s impossible to know exactly how large a benefit one can expect. This known unknown makes it very difficult to save and invest for retirement. Evidence suggests that Social Security uncertainty does impact investment decisions. Individuals with private pension accounts have enough uncertainty to deal with as is: asset return rates, life expectancy, and so on. Social Security is supposed to be the thing they can count on. It's unfair to kicking that problem down the road.

ON FRIDAY, I attended an event at the Brookings Institution called "State Roads to Economic Recovery". The gist of the programme was pretty clear. Washington is gridlocked. State governments are slashing away at core spending. What can be done to draw some growth-supporting policies out of this mess? If useful actions are likely to emerge from governments, the assumption seemed to be, it's at the state level where the policy experiments will take place, and where good ideas will be found. Though the participants were all fairly clear on what those ideas should include: spare crucial investments in things like education and infrastructure, get more efficient in operation and use of revenue, get more efficient in the raising of revenue, and so on.

I suppose it ended up being a mildly encouraging event. The great hope is that at least some of the state governments out there will use the crisis as an opportunity to adopt politically difficult policies that are nonetheless very good ideas—things like congestion tolling on crowded roads, or the use of public-private partnerships to build infrastructure. And perhaps some states will rise to the occasion.

But the thing that kept bugging me throughout the day was the problem in focusing on a state-level approach to recovery. Every state wants to retain residents, retain businesses, invest in key assets, and so on. But one of America's great strengths has historically been its fluid national labour market. When deep recessions hit, labour can move relatively easily from places where conditions are slow to improve to places where recovery is occuring faster. This mobility speeds national adjustments and gets the economy back up to speed faster than would otherwise be the case.

There was a sort of sideways acknowledgment of this truth whenever the subject of Texas came up. Aside from the advantages of having an oil industry amid high oil prices, what can we learn from Texas' success? Well, that it's an economic boon to absorb several hundred thousand new people when your economy is lagging. The extra demand helps make up for the reduced spending by existing residents, preventing the economy from declining as steeply (thereby attracting still more new residents).

But not every state can benefit from adding new people (nor should they). One panel featured two officials from the state of Michigan, which has suffered from a long period of decline and which continues to seek ways to right the ship. It would be possible, even easy, to resurrect Michigan. What would it take? Start with a special visa programme, in which skilled immigrants from other countries are offered easier visa terms and an expedited road to citizenship if they accept a visa that requires them to work in the Detroit area for five years. Follow that up by endowing a massive, DARPA-style energy research laboratory in the Detroit area. Set up special venture capital funds that offer excellent loan terms to start-ups connected with the lab or area universities, if they're willing to locate their new business in Michigan. Set up a special economic zone in southeastern Michigan that features an "invisible" border with Canada. Build high-speed rail lines from Detroit to Chicago and Toronto. Do all that, and I guarantee you that Detroit will be growing like mad in ten years. Honestly, even the visa programme alone might generate a turnaround.

The question is: to what end are we resurrecting Michigan? If the goal is to help the residents of Michigan, it would be much cheaper and easier to do so by investing in those individuals, in order to help them move to more successful local economies. Indeed, without investments in the people of Michigan, it's not clear how much a turnaround in the state's fortunes will benefit existing residents. Many have stayed in the state because they love the place, no doubt, but many others have not left because they're unprepared to find success in growth industries elsewhere. Moving the growth industries to their backyard won't change that fact.

If you're the governor of a declining state, you can't help but do everything you can to return your state to growth. But it's important to remember that the best thing for the American economy as a whole will often be for people to leave lagging areas.

TODAY'S recommended economics writing:

• Avoiding the coming growth slowdown (Brink Lindsey)

• College costs aren't the main problem (Economix)

• The economic silly season is upon us (Wall Street Journal)

• Are friends important in educational outcomes? (Vox)

IN THE course of writing this week's Economics focus about the 20 best papers ever published in the American Economic Review, I learned that:

1. Some acronyms age better than others.
2. Avinash Dixit and Joseph Stiglitz once made a case for taxing American football and subsidising opera. (See p.307)
3. Paul Douglas of Cobb-Douglas fame was a remarkable man. (A Quaker, he nonetheless joined the Marines at the age of 50, earning two purple hearts, before serving three terms as Martin Luther King Jr's favourite senator. Most memorable, however, were his prewar tussles with his fellow Chicago aldermen, "the smartest bunch of bastards I ever saw grouped together").
4. Remarkable though Douglas was, he and Charles Cobb did not invent the Cobb-Douglas production function.
5. Even if they had, perhaps they shouldn't have.
6. There's nothing new under the blistering sun. On p.48, Thomas Means, a former project engineer with Truckee-Carlson, anticipates Hernando de Soto by about 75 years. And on p.947/8 does Kenneth Arrow not anticipate John Rawls?
7. Franco Modigliani and Merton Miller thought whole milk was better than skimmed. (See p.279)
8. The word "adverse" in the term "adverse selection" is an adjective not an adverb.* (See p.964)
9. The average bill for surgery in Birmingham, Alabama, in 1953 was $99. (See p.963)
10. This I already knew: the third part of Friedrich Hayek's 1945 article, "The Use of Knowledge in Society", is one of the best intellectual tributes ever paid to society's chancers, opportunists and wheeler-dealers. Being in the right place at the right time, argues Hayek, is quite as socially useful as being the "right" man for the job in some abstract sense.
11. The 20 best papers in the AER's history average about 1.3 numbered equations per page

* Update: I realise that's a bit cryptic, or possibly illiterate. All I mean is that the term refers not to the process of selecting adversely, it refers to the result: an adverse selection. 

A NUMBER of critics of pro-labour leftists have pointed out the ways in which labour unions have impeded important reforms in recent years. Perhaps, responds Kevin Drum, but if you look at the language used by anti-labour Republicans, you see that crushing labour isn't about clearing a path to reform. It's about something more like defeating a spiritual enemy. So maybe we shouldn't cheer their fight against unions as a step toward a better run state.

But let's turn the question around. To many without a dog in the labour fight, the outpouring of support for unionised workers in Wisconsin looks like cheering for one's own team. That impulse is understandable, but what lies behind it? What's the end to which stronger unions is a means?

In a long piece at Mother Jones, Mr Drum gives some sense of what he's looking for:

If unions had remained strong and Democrats had continued to vigorously press for more equitable economic policies, middle-class wages over the past three decades likely would have grown at about the same rate as the overall economy—just as they had in the postwar era. But they didn't, and that meant that every year, the money that would have gone to middle-class wage increases instead went somewhere else. This created a vast and steadily growing pool of money, and the chart below gives you an idea of its size. It shows how much money would have flowed to different groups if their incomes had grown at the same rate as the overall economy. The entire bottom 80 percent now loses a collective $743 billion each year, thanks to the cumulative effect of slow wage growth. Conversely, the top 1 percent gains $673 billion. That's a pretty close match. Basically, the money gained by the top 1 percent seems to have come almost entirely from the bottom 80 percent.

Underlying this argument is the view that changes in the income distribution over the past few decades had everything to do with power and nothing to do with anything else. It suggests that growth produces a pool of money which is then divided among citizens based on their clout in Washington. But this is not a very realistic description of recent economic history. As Mr Drum acknowledges, manufacturing employment has declined steadily, and this has been true across the rich world. Labour unions were powerless to prevent it, except by closing off the American economy. And the loss of manufacturing jobs meant the end of a unique era, in which a large share of the population could earn a healthy paycheque doing work that didn't require a college education.

And so several trends have buffeted all of the rich world. Inequality has grown as the demand for skills has increased while college completion has leveled off. Top inequality has grown in no small part because of the rise of superstars; it's easier than ever for an individual talent to turn themselves into a global megabrand. And yes, part of the rise in incomes at the very top has been due to a related effect: the ability of a small group of people to manage enormous sums of money and take home eye-popping returns.

But is this what labour is about: finding the political will to tax billionaires at a higher rate? Perhaps a worthy cause, but not the sort of thing on which one builds a middle class. Is it to look more like Europe? Inequality has grown there, as well, though transfers have mitigated the impacts. But in Europe, incomes and growth are also lower, and many countries are saddled with unsustainable budgets. I think there is a workable northern European model of higher taxes, stronger safety nets, freer markets, richer populations, and more equal distributions of income. But these goals are often achieved at a cost, like reduced immigration. Neither is it clear that America ever had the political temperament to move toward such a model.

I can imagine a world in which better and more equitable decisions were taken in recent decades, and I can imagine that a larger union presence would have facilitated some of those better decisions. I can also imagine unions blocking others that might have been justified. Who knows what the net result would have been. But one thing seems clear—labour supporters in the grip of nostalgianomics (not my coinage) are doing too little to grapple with the real economic changes that have taken place alongside and accelerated union decline.

CONDITIONS have deteriorated in Libya, where open civil war appears to have broken out. Some of Libya's oil production has been disrupted, and prices continue to rise around the world. How serious are matters? Economist James Hamilton, who has done extensive work on the relationship between oil prices and business cycles, writes:

My bottom line is that events as they have unfolded so far are not in the same ballpark as the major historical oil supply disruptions, and are unlikely to produce big enough economic multipliers that they could precipitate a new economic downturn. They might shave a half percent off annual GDP growth, but I don't anticipate a whole lot worse than that.

And I think that's right. It's a little worrying that Treasury yields continue to fall, along with non-energy commodity prices and equity prices, but so far these shifts are not nearly as large as they were during the first months of the European crisis last year.

But Mr Hamilton also notes:

But the worry of course is that the big geopolitical changes we've been seeing didn't stop with Tunisia, and didn't stop with Egypt. So maybe it's not a good idea to assume it's all going to stop with Libya, either.

The interesting thing about recent market moves is that they're pricing in the possibility that instability speads. And it well might. But for now, all eyes are on Libya, where the primary danger is not to the global economy but to those caught in the conflict.