Using the government's previous formula, inflation would reach 18% in 2022

Many commentators, especially those defending President Biden's economic record, are puzzled as to why Americans are so dissatisfied with the state of the American economy. They rightly point out that unemployment is back to pre-pandemic lows and official inflation is falling. So why are Americans ignoring what many experts say is a strong economy?

The answer, according to a striking new paper by a group of economists from Harvard University and the International Monetary Fund, headlined by former Treasury Secretary Larry Summers, is that Americans have realized what experts have ignored. That's true. A portion of inflation as a normal increase in commodity prices. “Concerns about borrowing costs, which have historically tracked the cost of money, are at their highest level since the early 1980s,” they wrote. “Proxy measures of inflation, including borrowing costs,” account for most of the gap between experts' rosy outlook and Americans' skeptical assessment.

Inflation is not an objective number and there is room for judgment.

At the heart of the problem is a misconception that plagues academics, journalists, and ordinary Americans. The idea is that the official inflation rate is an objective number, unaffected by human bias. This is the same as being able to objectively measure someone's height or weight. ruler and scale.

In fact, the formula used to calculate the inflation rate is: subjective. Economists have to make hundreds of decisions about how to assess the overall trajectory of prices. What goods and services should be included in the formula's price “basket”? How should those goods and services be weighted against each other? Do the poor consume different things than the rich? How do we account for the fact that people in different parts of the country may consume different things at different rates? The best way to measure changes in the price of something as important as housing is to What is the method?

The most widely used measure of inflation in the United States is the Consumer Price Index for Urban Consumers (CPI-U) published by the U.S. Bureau of Labor Statistics (BLS). This formula has been revised many times since its creation in 1919.

Consumer prices no longer include the price of money

Most notably, as Summers and co-authors Marijn Bolhaus, Judd Kramer, and Carl Schulz point out, in 1983 the BLS removed interest costs from calculating consumer price inflation. It has been excluded. BLS economist Robert Gillingham argued at the time that including mortgage rates in the CPI formula overstated inflation. Instead, the BLS should estimate how much homeowners could be charged if they rented out their homes and use that to calculate housing inflation, Gillingham argued.

This change had a significant impact on CPI calculations, Bolhuis et al. write, because they removed home prices and financing costs from the official CPI formula, even though everyday Americans still This is despite experiencing those costs. His new CPI measure, “Owner's Equivalent Rent,” is equivalent to more than a quarter of his Consumer Price Index today.

Borhuis et al. He points out that removing interest costs from the CPI is not just a housing issue. “New and used cars together account for almost 7% of CPI,” but “financing costs are not included,” they point out. This makes no sense considering that he four-fifths of all new cars were purchased using car loans.

Additionally, although more people are purchasing consumer goods with credit cards than with cash, credit card interest costs are not included in the BLS's official formula. “Measuring the cost of living excluding financing costs,” Bolhuis et al. argue, “will underestimate the pressures on consumers who rely on credit for many purchases.”

What would inflation look like under the pre-1983 formula?

Borhuis et al. They then looked at whether the official CPI figure could be recalculated using a pre-1983 formula that incorporated mortgage interest rates, car loan interest rates, and credit card interest rates into the cost of living. They found him three things. The first is that with the pre-1983 formula, the forecast for inflation in 2022 and 2023 is dramatically different, peaking at 18 percent in November 2022.

Second, consumer sentiment, as measured by the widely used University of Michigan Consumer Sentiment Index, is much more strongly correlated with the pre-1983 CPI formula than with the modern CPI formula, which excludes interest costs. It turns out that it is.

Third, we found that these differences also hold true in Europe. Higher interest rates correlate with lower consumer confidence, and vice versa. This was an important finding, as some have suggested that the gap between American consumer sentiment and official government statistics is a result of Americans' distrust of institutions and mainstream information sources. “Despite heightened partisanship, social distrust, and overall reported levels of 'referred pain,' we find little evidence that the United States differs significantly from its peers in economic perceptions.”

“While consumers include the cost of money in their perspective on economic well-being, economists do not,” the authors conclude. Home and auto purchases are “vital to American consumers' sense of economic well-being, but their prices are not included in official inflation measures, which is why those sentiments lag traditional measures of economic performance.” No wonder.”

Differences between CPI and pre-1983 formulas may widen over time

There are other obvious problems with relying on something that is on the decline. rate Official CPI inflation rate to determine what consumers should feel. Inflation is cumulative. Even if the inflation rate declines, the increase in prices from the previous year will not be reversed. It simply means that prices are increasing at a slower rate.

Most importantly, the ever-expanding federal debt could make excluding interest costs from CPI and the Federal Reserve's recommended measure of consumer spending increasingly problematic over time. That's true.

As the debt increases, the federal government must borrow more money from U.S. and foreign investors. But companies that want to lend to the United States will demand higher interest rates to lend us that money because they see the United States as increasingly bankrupt. Higher government borrowing rates lead to higher rates on mortgages, credit cards, student loans, auto loans, and all other forms of borrowing. And, as we've seen, these higher interest rates lead to higher price inflation, whether the Bureau of Labor Statistics sees it as such or not.

In recent years, the Federal Reserve has curbed these interest rate increases by printing new dollars out of thin air to lend to the U.S. government. But printing new money can also cause inflation because it reduces the purchasing power of existing dollars in circulation.

We need a healthier debate about how to measure consumer price inflation

Those who believe in the primacy of experts have long attacked those who question the accuracy of the BLS's inflation measures. Balaji Srinivasan is a venture capitalist and entrepreneur. criticized Torflation is an attempt to independently develop a measure of inflation using real-time price data from a variety of sources.

But whether you like the truffled methodology or not, we need to encourage independent thinking about how best to measure prices in the economy. As the IMF and Harvard University analyzes show, the Bureau of Labor Statistics can get it wrong. My colleagues Jackson Mejia and John Hartley at the Equal Opportunity Research Foundation argue that even relatively low inflation rates can reduce poverty because the poor cannot afford to absorb higher consumer prices. It was shown that the damage caused disproportionately to the layers.

It is important and healthy to focus on different measures of consumer prices. Everyone has a stake in the outcome, especially those living paycheck to paycheck.