Before there was “fake news,” there was “fake inflation” news.
Dark talk about skullduggery and conspiracies around inflation calculations was a feature of the internet long before President Donald Trump even dreamed of riding down the Trump Tower escalator to announce his presidential bid.
In an effort to short-circuit the process this year, with the U.S. May consumer price index report on Thursday, here are a few common misunderstandings about inflation that can spiral into conspiracies along with some facts to debunk them.
One guiding principal to keep in mind. In general, the Federal Reserve doesn’t want to overestimate inflation. That would unnecessarily keep the economy from running at full strength. That lost output means less jobs and income and ripples out into the economy.
- Most Americans have heard of the consumer price index, yet the Fed’s “favorite” inflation measure is the personal consumption expenditure price index. What gives?
The consumer price index is the most widely used measure of inflation. It affects millions of Americans because Social Security uses it to adjust pension income payments. So its important and the market doesn’t ignore it.
In 2012, the Fed decided not to use the CPI as its target price index mainly because it is a fixed basket of goods.
Think of the CPI index “as your shopping basket,” said Brian Bethune, professor of practice at Boston College. “It is geared to high frequency types of purchases,” Bethune said.
The Fed likes the PCE index better because it fluctuates. For instance, if beef prices rise, many households will “substitute” and eat more chicken. So this is a measure of what consumers “actually” consume.
As a result, the CPI tends to show more inflation than the PCE. Data from the St. Louis Fed show that from January 1995 to May 2013, the average rate of inflation was 2.4 percent when measured by headline CPI and 2.0 percent when measured by headline PCE.
- Why does the Fed often talk about “core” inflation that excludes food and energy rather than “headline” inflation that includes all prices. Don’t they know that is what we spend our money on?
Yes. The Fed knows that households spend most of their income on weekly groceries and putting gas in the tank. The trouble is these prices are volatile and the Fed doesn’t know how long the higher prices will last. Most don’t last very long.
Not knowing how long a price will last makes it impossible for statisticians to amortize the move over time, said Robert Brusca, chief economist at FAO Economics. For instance, if oil is in the $50 range and then it moves up to $80., economists don’t know how long it will remain at that price. “If we knew that, we could amortize its impact on the indices But we don’t know that, so the best thing to do is exclude it and measure the inflation of other things,” Brusca said.
- House prices and equities have risen sharply. Why isn’t that counted as inflation?
“We don’t consume assets. The cost of living in a home you own is measured by the rent you would have to pay,” said Joseph Gagnon, senior fellow at the Peterson Institute for International Finance. Its a bit tricky but the CPI data assumes home owners are renting their house from themselves every month. It’s called “owners equivalent rent.” And its part of a category called “shelter” that has more weight in the CPI than the PCE. And when your house appreciates so that it is worth more than the rent, that is an investment return, a type of income, and not a price, Gagnon said.
- The cost of my afternoon junk food keeps going up. That’s how I know there’s inflation
The price gains you notice in your daily life are called “relative” price changes by economists. That’s the ordinary course of everyday life – some prices go up for different reasons and some prices go down for different reasons. Inflation is when all prices move together.