What’s The Matter
The divergence of official inflation as measured by the government versus inflation realized by the consumer and businesses has never been greater, in our opinion. Go ask anybody on the street in America and Europe if they think “doing life or business” is getting more expensive.
We have some thoughts on what is the matter with the inflation data:
- Defining inflation – what is your definition of inflation? What are we trying to measure? The prices in a consumer basket of goods and services? Wages? Asset prices?
- Measurement problems – the official measurement procedures seem archaic given the advent of big data in the past few years. Even Bloomberg is out with a recent piece warning the Fed about low-balling inflation due to measurement errors.
Low-Balling Inflation Puts the Fed at Risk
Beware of any metric that doesn’t fully reflect housing prices.
The U.S. has an inflation problem. It has nothing to do with inflation being too high or too low. Unlike the raging inflation of the 1970s, it doesn’t need to be solved with a lengthy and painful recession. Instead, it is a problem of measurement because the cost of housing — the single biggest expense for many Americans — isn’t explicitly included in the inflation data.
…Recent research from the Bank for International Settlements finds that the transmission mechanism for monetary policy has shifted. In their paper “Monetary Policy Transmission and Trade-Offs in the United States: Old and New,” Boris Hofmann and Gert Peersman concluded that changes in monetary policy — rate hikes or rate cuts — are being filtered into the economy increasingly through housing prices and less so via businesses raising prices as in years past. So even though the Federal Reserve’s policies are causing those prices to rise, they aren’t registering in the form of higher overall inflation.
..This creates a troublesome landscape for executing monetary policy. The Fed is wedded to a 2 percent annual inflation target without being able to get a reliable read on whether it is accomplishing that goal.
– Bloomberg, September 28
- Shrinkflation – companies are finding ways to raise prices without raising prices. Paying the same price for, say, a bag of M&Ms with now only 20 candies compared to last year’s 32 candies is inflation in price per unit. This should be adjusted for in the government stats, but we doubt they capture all of it. Even if they try, it is unlikely they can keep up with the reality of the gazillion prices in just the domestic the economy.
- Over massaging the data – hedonic price adjustments by the BLS is total B.S.. The government economists make quality adjustments to prices. Alan Greenspan used to use the analogy of eye surgery when explaining hedonics. Let us paraphrase Greenie to make our point: Historically, eye surgery would cost you $100 in current dollars but was done with a hacksaw. Today, eye surgery is done with laser technology and costs $10,000. Adjusting for the quality of today’s surgery, the price has not increased. Seasonal adjustments? We would love to buy at some of those seasonally adjusted prices. We call bullshit.
We could go on and on and on about the many problems with how inflation is defined and measured.
In The Government’s Interest To Keep Inflation Data Low
Keep it in perspective, comrades, the government has an interest in keeping the inflation data low. The U.S. policymakers changed how housing is calculated in the CPI after the big inflation of the 1970’s. Remember, social security payments have cost of living adjustments (COLAs) linked to inflation. Imagine if inflation breaks out with all the boomers joining the SS ranks? Big problem.
The government’s interest in keeping inflation low is even greater now given the high debt load that most developed countries are carrying.
Nasty Feedback Loop If “Inflation” Picks Up
Ponder the ugly feedback loop: “Inflation” increases, interest rates rise, which increases interest payments on the Yuuge national debt. The larger budget deficit alone is inflationary, but, in the future it is likely to be monetized. This will accelerate inflation as inflationary expectations increase. Nasty spiral.
Monetary policymakers know the downside of a ugly debt deflation and makes them understandably cautious about raising interest rates even though they are sowing the seeds of the deflation they fear most as they blow more and more asset bubbles, which all will inevitably burst. Coming out of the Great Recession they suffer from “recency bias.”
It seems we now live in a type of Hegelian dialectic progression of deflation/inflation with the synthesis being asset bubbles, which immediately sow the seeds for another round of deflation/inflation. Comrades!
Furthermore, real wages decline if real-world prices are rising regardless of how inflation is being measured, correctly or incorrectly. It may explain, in part, the punk economic recovery and the rise of populism. That is real wages are lower than what is currently measured.
So, when we see headline inflation defined as low, or the words lowflation, we think, and hate to say it, “Fake News!”
The markets should see through the inflation data but don’t care as they are having too much fun making money.
Nevertheless, our friends at Focus Economics are out with a great infographic on inflation in the ‘zone, which we thought you should see.