My advice to the Fed on "Low inflation": use a different index to shout loudly and tell BLS to be less aggressive with "Hedonic quality adjustments"

0
43

The Fed could immediately claim victory and take compliments.

For the first time in history, the Fed is officially and vocally considering the use of monetary policy to increase inflation, or at least inflation expectations. Last Friday, it was the turn of the president of the Chicago Fed, Charles Evans, to pierce this message in the minds of consumers and recalcitrant workers, whose fruits of their labor are devoured by inflation:

"Because inflation expectations appear to be below our 2% target and it was stubborn … it tells me that our current policy stance is on the restrictive side," he said. he told reporters. This year sees two rate cuts of 25 basis points each, not because the economy needs them, but to inculcate consumers and workers that their hard-earned dollars have not lost their buying power. fast enough, and that they should change their attitude and gratefully expect more inflation.

But the problem is not that there is not enough consumer price inflation. C & # 39; very much Everyone has their stories. Inflation is different for everyone. When your rent rises by 10% and 50% of how much you earn, you rent and when, in addition, your health insurance premium rises by 30% and 20% of what you earn goes to your health insurance, regardless from the way you look at it, you have a load of inflation on your hands.

And so you can deal with this increase in your costs of life, that's 3% wage inflation, hahahahaha ….

Other people do not face this kind of massive inflationary pressures. They can live in places where rents are flat. People who own their homes – over 60% of families – face little inflation on the housing front unless they move. Electronics, furniture, appliances, clothing, shoes and many other things have become cheaper over the years if you know how to use the Internet. So it all depends. And everything is mediated throughout the United States, across the United States, and these figures are summarized in various indices of consumer price inflation.

The index of consumer price inflation that the Fed uses as a criterion for its "price stability" target of 2% is the PCE index. This index usually shows the lower inflation of the main indices. And the Fed focuses on the PCE index without food and energy because these two categories are highly volatile; food and gasoline prices may rise and fall.

The Fed's goal is "symmetrical", as it continues to say, which means that inflation can be a little above or below the target without triggering a monetary response.

Then there is the consumer price index, or CPI. It also comes with a "core" version without food and energy, which makes it much less volatile. The CPI is usually higher than the PCE index.

There are constant complaints about the IPC – which do not reflect the greater weight of the cost-of-living increases experienced by consumers and workers. As mentioned above, everyone experiences inflation differently, and nobody will be happy with any national media, but this is what we have.

Nevertheless, the IPC core is a less unrealistic notch than the PCE core. The chart shows core PCE (blue) and core CPI (red), and the Fed's target (green). Notice how the red line (core CPI) was slightly above or below the Fed's target in a fairly "symmetrical" way from the Great Recession. If the Fed chooses the IPC core as its objective, its mission of "2% price stability" is accomplished, and would have been accomplished for years, and can pocket global compliments to "accomplish" its mission:

To further improve the Fed's success rate, after passing its benchmark to the core CPI, the Fed could have hailed the Bureau of Labor Statistics (BLS), which puts together the CPI, to be less aggressive with hedonic qualities ".

The "hedonic quality adjustments" have a conceptual meaning. For example, with cars. They are much better today in a myriad of ways than when they were in 1980. Performance, comfort, safety (multiple airbags, side impact protection bars, curl areas, anti-lock brakes, traction control, alarm systems, etc.) ), Dream electronics in the 80's, backup cameras, suspension systems, emission control systems, materials, durability, etc. This costs money for development and construction.

So, if the new cars improve from year to year, this additional cost, as it is added to the price of the car, is not conceptually inflationary because you are getting a better product and therefore you pay more. The cost of living increases, but you are presumably safer and more comfortable and get a better quality of life.

This is a key aspect of inflation: if the cost of living increases because you are buying higher quality products, the part attributed to higher quality costs is not inflation: Yes, life becomes more expensive, but it is better presumably, and that part is not inflation. Inflation is when the same thing with the same qualities becomes more expensive.

Therefore, price increases based on product improvements are adjusted outside of the inflation index. These "hedonic quality adjustments" for new vehicles are based on these factors, according to the BLS: Reliability, durability, safety, fuel economy, maneuverability, speed, acceleration / deceleration, load capacity, comfort or convenience and equipment added or canceled.

This gives us a situation where new vehicle prices have not substantially shown any inflation since 1997, while actual transaction prices have risen:

Conceptually, I get these quality adjustments. But they are applied to many items, such as consumer electronics and biggie, housing costs (rent and "equivalent" in primary residence rent, "which means a nicer apartment, house or condominium). And even slightly aggressive quality adjustments, distributed among the items in the basket, have a significant impact in the peculiar world of judging the Fed, where people work on one or two tenths of a percentage point – say, an annual inflation rate of 1, 8% (below target = Fed failed) versus 2.0% (on target = Fed was successful).

But these quality adjustments are aggressive – and probably overly aggressive enough where actual inflation is undervalued by a relatively small amount that makes a huge difference with regards to monetary policy where a five-tenth of a point change percentage may induce Fed judges to go into hyperventilation, especially on the undershoot side.

So the Fed must first pass its benchmark from the PCE core to the CPI core, which would solve almost all of its current "low inflation" problem in one fell swoop.

And then, once the move has been made, the Fed needs to arrange the data points so that the BLS is less aggressive in its quality adjustments. Just a little here and there. And the IPC core, even with today's price data, would be uncomfortably high compared to the Fed's target and "low inflation" would have been won.

The Fed could claim victory on the "low inflation" front and pocket the compliments and build its iron credibility that will always be able to win "low inflation". And then, he could bring back his rhetoric to worry about how to contain inflation, and how this inflationary push was only "transitory" or anything else.

Oh, it's all right. But we are a bit picky about calling it. To read… With all this Money Printing, where is the huge inflation?

Do you like reading WOLF STREET and do you want to support it? Using ad blocks – I fully understand why – but do I want to support the site? You can donate "beer money". I appreciate it immensely. Click on the beer mug to find out how:

Would you like to receive an email notification when WOLF STREET publishes a new article? Sign up here.

LEAVE A REPLY

Please enter your comment!
Please enter your name here

This site uses Akismet to reduce spam. Learn how your comment data is processed.