Federal Reserve Chair Jerome Powell conceded during a recent International Monetary Fund (IMF) event featuring several of his counterparts that the global economy will experience a new period of elevated inflation, despite plans to curb the consumer price index (CPI) with a blend of higher interest rates and balance sheet runoffs. After a year of transitory talk, this was quite the concession for the head of the world’s most powerful central bank. But there is another piece to this inflationary puzzle: How can the institution fight 40-year high prices with understated calculations? This is what is ignored in the arena of economic and political discourse.
Ultimately, there are two components to the inflation discussion today: stickiness and understatement.
Inflation Feels Sticky
A key principle in the field of economics is the ratchet effect. This is a concept that explains prices are fast to accelerate but challenging to reverse, regularly found in public policymaking and business operations. Suffice it to say, it is easy to increase the size and scope of organizations, acclimating to adjustments in the broader economy or political landscapes. However, when emergencies, downturns, or inflationary environments subside, the reversal is a slow and steady adaptation. Indeed, in today's current economic conditions, inflation is a sticky substance that is hard to disinfect.
Right now, economists are debating whether the 8.5% annual inflation rate seen in March has peaked or if the CPI, the producer price index (PPI), and the personal consumption expenditure price index (PCE) will begin to fall moving forward. Whatever the case, when you are in a low- or middle-income household, does it really matter if the cost of living increase is 8.5%, 7.2%, or 6.65%? Not really, particularly when the Fed engages in quantitative tightening and makes debt and borrowing far more expensive.
Austrian theorists will purport that inflation is the most odious tax because it is hidden, stealthy, and a long-term pain in the wallet. When America's inflation addiction began in 1975, the CPI launched into the stratosphere, with only intermittent periods of slowdowns, thanks to inflation-buster Fed Chair Paul Volcker dramatically raising interest rates. But this did not appreciate the US dollar's purchasing power or dissipate inflationary pressures. Over the next decade, the same trends will form, be it the CPI or the PPI: Prices will continue to climb after injecting trillions of dollars into the marketplace in just two years.
But this brings us to the next point: The US government’s calculations understate inflation.
An Understatement of the Century
If the Bureau of Labor Statistics (BLS) calculated inflation the way bureaucrats did prior to the 1990s, the go-to measurement would be a lot higher than what is being reported today. While this is indeed a political tool to help Uncle Sam's wallet, reduce the Social Security Administration's obligations, and prevent the Federal Reserve from dismantling the national economy, it does far more harm than good for millions of Americans. The number crunchers utilize a series of methods to minimize the inflationary effects of fiscal and monetary expansion.
The first trick is to remove specific components from the CPI, including housing prices. Washington's excuse is that real estate is considered an investment, not a place to keep a roof over your head. Rent, on the other hand, is a service that consumers pay for from a landlord. It is estimated that if the cost of buying a home, which is currently at an all-time high, were added to the monthly figures, inflation would be approximately 2% higher.
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The second measure employed is by altering weights. The CPI is compiled by a fixed basket of aggregate weights of goods and services in the broader economy, such as food, apparel, energy, and transportation. BLS officials will modify the data based on what shoppers consume. During the coronavirus pandemic, consumers shifted their spending to eat more at home than at restaurants, so the federal agency modified the weights. Now, there are two tactics that the experts utilize: the cost of goods index (COGI) and the cost-of-living index (COLI).
For example, if pork prices rise, households might substitute pork chops for a cheaper meat product, like chicken. A COGI calculation would continue monitoring pork's price hike to identify how much inflation is in the US. However, COLI would allow pork to be swapped for a less expensive type of meat while trimming its weight in the CPI. This method is slick since it consists of fudging the numbers.
Inflation Inferno
No matter how you frame it or determine how high prices are, inflation is terrible. In the beginning, it might function as a coquettish mistress that can fulfill your desires of something-for-nothing, extending unpaid presents to the public in exchange for votes. However, like The Picture of Dorian Gray, there is a portrait hidden in a closet somewhere that exposes the growing iniquities of printing money in perpetuity to ensure the federal government does not try to embrace a modicum of fiscal responsibility. Eventually, Mephistopheles comes for the nation’s collective souls, igniting an inferno of price hikes throughout the entire economy and spawning an affordability crisis, be it filling up your automobile with gasoline or keeping the lights on in your home. Swamponomics strikes again.
