Forbes Article:A Deflation Alert Hidden in the Latest CPI Indicators
Mate27
TUSCL’s #1 Soothsayer!
I can’t tell you how many detractors I’ve had regarding this topic since the summer of 2022, mainly SkiDumb, Mark, and Rickyboi. Feels great to have some vindication from Forbes backing me up on this topic using pure analysis, in spite of the parsing words from the Federal Reserve and Larry Summers. Will I ever get the credit? Only intelligent people will understand the corrective predictive analysis and tip their hats to me saying “I told you so”! Some text from the article as follows…
Consider the following three sentences — all taken from a single 250-word article in Friday’s Financial Times (January 27, 2023) reporting on the release this week of the Personal Consumption Expenditure Price Index (PCE) for December.
“US stocks waver as inflation edges higher.”
“US consumer spending softened in December even as inflation eased.”
“Headline inflation fell to its lowest level in more than a year in December.”
The truth is that today’s PCE figure confirms that the post-pandemic inflationary episode which has bedeviled economists and markets for the past 18 months or so… is over. Definitively.
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Fed was late in detecting inflation, and it will be late to respond to the end of the cycle. This risks feeding a pro-cyclical impetus into the real economy’s slowdown and, potentially, bringing on the recession that many fear.
Let’s do the numbers.
Too Many Metrics
The first problem is — there are too many numbers to choose from. To start with, every month the federal government publishes two “headline” inflation numbers. The Bureau of Labor Statistics (a branch of the Depart of Labor) releases the Consumer Price Index (CPI) typically around the 12th of the month, and the Bureau of Economic Analysis (part of the Department of Commerce) publishes the Personal Consumption Expenditure Index (PCE) about two weeks later.
The PCE vs the CPI
The confusion begins with the two headline figures. The CPI and the PCE are designed to measure the same thing, so one should expect they will generally agree. Until Q2 2021 – when our inflation outbreak really got going – they did agree.
But since then, they have diverged significantly. The long term “gap” between the two metrics had been small (the CPI was less than 2/10ths of a percent higher). But as inflation has accelerated, the gap has widened by a factor of 8.
This is troubling. If two bathroom scales give different answers, but the difference is small and consistent, we accept it as an ordinary variation in the manufacture or calibration of the two mechanisms. But if one scale starts producing answers that differ by a large and growing amount from the other, the conclusion must be that there is something wrong with one or both of them.
Part of the problem is clear: the CPI is badly broken. This has been known for a long time. Congressional hearings and formal studies of the problem dating back to the 1990’s identified a systematic over-estimation of inflation by the CPI. Economists have estimated that the measurement error has contributed trillions to the federal deficit. The CPI is the benchmark for cost of living adjustments for social security payments, military pensions, and many other entitlements. (These problems are detailed in a previous column, here.)
The Federal Reserve itself recognized the problems with the CPI over twenty years ago, and replaced it with the PCE for purposes of setting monetary policy.
But the recent divergence is related to a more serious problem. It calls into question whether our conceptual understanding of inflation, and our techniques for measuring it, remain valid in a post-industrial, service-dominated and increasingly digital economy.
This intellectual reckoning is overdue. Inflation was “invented” as an economic concept when the economy was based on principally mass production of commoditized products. It “works” for assessing the cost of gasoline, say, or eggs. It works (to a point) for labor costs involving farm labor, hourly wages for “metal bending” jobs in a factory, or piece-work in the garment industry. But economists today struggle to apply it to services, to the compensation for knowledge work (e.g., doctors, chip designers, educators), to housing costs, and to products that embody high-tech features enabled by software, realtime data, and network connectivity.
Deflation Is Here
But even aside from these larger questions, the latest CPI and PCE figures raise doubts about the basis of current Fed policy.
The Federal Reserve is still of the official view that inflation rages on. The year-over-year PCE is just over 5%. Even if that is 140 basis points lower than the CPI, it is still seen as a serious problem. “By any standard,” Chairman Powell said recently, “inflation remains much too high.”
But is it the case?
Since the summer – that is, over the last two quarters, which is long enough to establish a baseline – the PCE measure of inflation has essentially achieved the Fed’s 2% target, at a continuously compounded annual rate. (For November and December, it fell below 1%.)
The CPI is even lower for the last two quarters.
The fact is that inflation decelerated swiftly during the 2nd half of 2022. The PCE fell from a 7.74% annual rate in the 1st half of the year to a 2.09% rate in the 2nd half. Similarly, the CPI dropped from 10.57% to 1.88%.
Returning to the matter of the difference between the two measures, annualizing the monthly changes shows that the discrepancy exploded in the 1st half of 2022 – as inflation was accelerating. In the 2nd half of the year, as inflation disappeared , the gap also disappeared.
In other words, the bathroom scale is most inaccurate precisely when it is most needed!
A 283 basis point difference is extraordinary. Something is out of whack!
The Lessons From All This
It is becoming clear (except apparently to the folks at the Federal Reserve, and Larry Summers) that the weather has changed.
The post-pandemic inflation surge, which began at the beginning of 2021 and peaked in he first half of 2022, has passed.
The inflationary episode was transitory after all.
The Fed’s official inflation target of 2% has already been achieved.
The prospect for deflation is real and should be heeded.
The Federal Reserve needs a new approach to measuring the price trends in the economy. The existing methods have become obsolete, and are producing inaccurate and misleading results.
The Fed’s response so far to this has been to search for new ways to parse the existing data, to justify preserving the illusion that inflation is still the most serious threat we face. Chairman Powell and others have taken to talking about Core and now “Super-Core” inflation (which excludes food, energy and housing costs), inflation for “non-housing services” as opposed to goods (most physical goods are showing clear deflation trends so ignoring them is a way to keep the heat on), wage inflation (which reflects labor market “tightness” — the pseudo-problem of the moment), etc. etc.
now.
“Inflation in December is likely to have run at around a 2.3 percent annualized pace on a 3- and 6-month basis, as compared with 5.1 percent on a 12-month basis.”
Still, Brainard’s speech was full of classic bureaucratic swagger: “Inflation is high,” she assured her audience, “and it will take time and resolve to get it back down to 2 percent. We are determined to stay the course… Policy will need to be sufficiently restrictive for some time to make sure inflation returns to 2 percent on a sustained basis.”
I told you so! I am right and you aren’t.
Are wages coming down or even stabilizing? No. Has the tightness of the labor markets slackened? Again no. Until that changes, inflationary pressures will continue to boil beneath the surface. Eventually those ever-increasing input costs have to be passed on.
It's also important to note that food costs continue their march upward and gas prices are rising again, both of which will be reflected in our next inflation readings. Rents are still rising fast too and while housing prices have dipped a bit, as a practical matter they are still way out of reach for many middle class prospects, especially given the current mortgage rates.
IMO the economy needs a complete reboot in order to rebalance back to a natural supply/demand equilibrium. This will involve a job killing recession. It will also help when the Obamacare subsidies finally return to normal and the state of emergency is ended, thereby re-instituting work requirements for EBT. Until we ease labor market pressures, we are just kicking the can down the road until the next inflation eruption.
Keep in mind, my call inflation peaked August of ‘22 was met with resounding resistance, and somehow even with all evidence pointing to me being right, confirmation bias sticks with the curmudgeons on this board. Maybe Mark should stick to conspiracy theories and you stick with single mothers needing a cash infusion.
But to agree with you just a little bit. I do think the Fed should at least stop raising rates for a while. Let's see if the increases are taking affect. Don't drive us into recession just to get inflation below 2% again.
Yes, momentary dip. The underlying conditions for further inflation problems haven't abated, but have only been temporarily suppressed. During the 70s they too had extended peaks and valleys, inevitably tied to the Fed raising rates just enough to temporarily suppress inflation before chickening out when the economy slowed and unemployment started to rise, which of course caused inflation to roar back. Rinse, repeat.
It's all about wages and the labor market. Until that problem gets solved, inflation will continue to brew under the surface. I guess we really are doomed to repeat our mistakes.
And again, food prices continue to rise at a healthy clip and now gas is joining back in. Expect the next inflation reading to reflect this.
Parsed words “it’s all about wages and the labor market”. Spoken like Larry Summers and the federal reserve, which this article addressed. FYI: the recent rise in gasoline is absolutely a “momentary blip” and conducts a small portion of inflation picture. Additionally, the only reason why has prices have momentarily lifters is due to refinery outages from the freezing weather we experienced during the holidays. Capacity is being brought back up and prices will soon be dropping again, adding to another round of “I told you so”! Ha ha. You just can’t stand it that I am right and you’re blatantly rong, hurting that fragile ego of yours.
The article made a couple of breezy subjective assessments in passing. Wages are baked into almost all of our goods and services, most especially including those that consume the highest % of household budgets (food, energy, automobile gas). If wages keep going up, so too will inflation.
Warrior, some prices are continuing to go up, but overall prices are not. Cars, commodities, and shelter are dropping. Food and some service are up, along with some service sectors. Again, parsing of the data. Glad you chimed in, because overall the whole point of my peak inflation call last summer wasn’t to say “look at me, I’m smart”. It was simply to point out the flaws the fed uses to read the indicators which will eventually pull us into a recession.
Bacon!!
Jajajajajajaja!! God you’re dumb. Just go ahead and die already. You killing yourself would be the greatest accomplishment in an otherwise pathetic life. Can’t wait for the final summer inflation print of 2023 to remind you “I told you so!”
Rolmfao!!!
https://apple.news/AUCiacdHSSW-6CUaebc41…