Lies, Damned Lies and Inflation “Statistics”*

My daughter, who works for the Bank of England, is studying for her Master’s in Economics at the University of Edinburgh, and sent me one of her papers. It was filled with a vast array of complex mathematical equations of which I could make no sense, despite being a mathematician by training and studying Economics at Oxford…..a few years ago.

The Federal Reserve has teams of economists plus input from Reserve Banks all around the country. The Bureau of Labor Statistics, which produces the Consumer Price Index (CPI), has another battalion of experts. All this talent must, one could fairly assume, produce sophisticated and accurate models for inflation.

Imagine my surprise, therefore, to discover that one key element, housing inflation – which constitutes one-third of the CPI and 40% of “core” inflation (excluding food and energy) – is an imputed number (“assigned by inference”), not an actual one.

Read what Nobel prize-winning Economist Paul Krugman wrote recently: ”How does the bureau measure housing inflation? Not by looking at the prices at which houses are sold, which fluctuate a lot with things like interest rates. Instead, it looks at how much renters pay — and for the large number of Americans who own their own homes, it imputes what it calls Owners’ Equivalent Rent, an estimate based on rental markets of what homeowners would be paying if they were renters (or, if you like, the rent they are implicitly paying to themselves).

The trouble is that this measure relies on average rents, which to a large extent reflect leases signed many months ago. A new Fed study shows that official rent measures lag market rents by about a year. And here’s the thing: Market rental rates exploded in 2021, probably as a result of the rise in working from home, but have since leveled off and may in fact be falling.

So official inflation measures are telling us about what was happening a year ago; they overstate current inflation and, perhaps more important, grossly understate the extent to which the inflation picture has improved. If you try to measure inflation excluding those dubious housing numbers, plus other volatile elements, you get a picture of dramatic improvement, almost enough to declare the inflation surge over.”

Let’s look at inflation. There are more gauges of inflation than the UK had Prime Ministers in 2022, but let’s just look at Personal Consumption Expenditures (PCE is the value of the goods and services purchased by, or on the behalf of, “persons” who reside in the United States.). (more…)