When the Main Stream Media quotes inflation numbers, unfortunately, they typically report Core CPI. There are two main problems with the Core CPI. The first problem is, “Core CPI” excludes food and energy costs. I have referenced the data from the most recent CPI data, from the BLS (Bureau of Labor Statistics). It lists 2.5% as the annualized inflations rate for the past three months (June to August, 2007)….excluding energy and food, which is also called the “Core CPI”. However, note the following numbers which are conveniently excluded from that 2.5%:
- Transportation (which includes such things as airfare, bus tickets, and car purchases) increased 9.4%.
- Energy increased 16%
- Food went up 4.4%. Of note here, also from the report, is a rise in the price of milk of 16.9% from January 07 to July 07 – approximately a 30% annualized rate….also excluded from the “inflation” number commonly quoted, but not excluded from the impacts to our pocketbooks.
The other very key discrepancy concerns the housing component of the CPI. To determine housing cost inflation, the survey asks a random sampling of homeowners the following question (again, I quote directly from the BLS CPI website):
“If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished and without utilities?”
They define Rental equivalence as follows: “This approach measures the change in the price of the shelter services provided by owner-occupied housing. Rental equivalence measures the change in the implicit rent, which is the amount a homeowner would pay to rent, or would earn from renting, his or her home in a competitive market.”
Housing - Owners’ equivalent rent of primary residence (BLS). CPI Data (2003: http://www.bls.gov/cpi/cpid03av.pdf, 2007:http://www.bls.gov/news.release/pdf/cpi.pdf)
2003 - 219.9 (This is the index number they come up with)
2007 - 246.15
Change: 11.9%
Housing - National Average - Based on sales price (Sales price data: http://www.census.gov/const/quarterly_sales.pdf)
2003 - $195,000
2007 - $246,500
Increase: 26.4%
CPI versus "Core CPI".
Fed's comfortzone for inflation is 2%.
Core CPI - 2002 to 2006: 2.1% increase annualized. Adjusted for home sales in place of "equivalent rent": 3.4%
NonCore CPI: 2002 to 2006: 3.2% increase annualized. Adjusted for home sales in place of "equivalent rent": 4.5%
So, I am suggesting that the inflation model used by the Fed may be fundamentally in error. The problem with this is twofold:
It is my understating that the Fed uses Core CPI data to determine monetary policy. Having never been in an FOMC meeting, it is difficult for me to verify the accuracy of that statement, but it is commonly stated in periodicals. “Monetary Policy” includes such things as the Fed Funds Rate and the amount of liquidity they pump into the system. A flawed model could result in the wrong decisions by the Fed. Now, some might say that the Fed is certainly smarter than that, and I will wholeheartedly agree. However, intelligence has a very quiet voice in any bureaucracy when it runs counter to policy. So, what exactly is the stated policy:
“Until the early 1980s, the CPI used what is called the asset price method to measure the change in the costs of owner-occupied housing. The asset price method treats the purchase of an asset, such as a house, as it does the purchase of any consumer good. Because the asset price method can lead to inappropriate results for goods that are purchased largely for investment reasons, the CPI implemented the rental equivalence approach to measuring price change for owner-occupied housing. It was implemented for the CPI-U in January 1983 and for the CPI for Urban Wage Earners and Clerical Workers (CPI-W) in January 1985.” Therefore, even if the Fed knows housing prices are increasing rapidly despite moderate increases in equivalent rent, the current policy prevents them from taking that into account when making monetary policy decisions.
In this case, the presumably flawed model could potentially result in an over-exuberant consumer. All markets rely on data and information. Compiling and analyzing the above analysis took me about 2 hours. What percentage of Americans is actually going to do that kind of research? I would guess it is in the 1% to 3% range, most of whom are academics publishing white papers in journals which are read by an even smaller portion of the general population. The question becomes, is an over-exuberant consumer necessarily a bad thing? While I believe the answer to that question is difficult, I do believe that the most efficient markets are based on accurate data.
