People's Inflation vs. Policymakers' Inflation: What Accounts For the Big Disconnect?
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What accounts for the big disconnect between people's inflation and policymakers' inflation? People consider the total costs of things; based on that measure, inflation remains relatively high. Policymakers view inflation differently, creating a disconnect. Analysts should call out the disconnection and help the Fed avoid another policy blunder.
Inflation Based on Total Costs
People's inflation views are based on the total costs of things; yet, nowadays, inflation measurement is based on list prices/cash transactions ( and excludes financing costs), which makes little sense as fewer and fewer cash transactions occur.
When it comes to measuring inflation, it's crucial to take into account the total costs of goods and services, which includes financing costs. These costs are not only significant in individuals' purchasing decisions but also have a direct or indirect impact on their inflation expectations.
The influence of financing costs on inflation measures is particularly evident in the case of high-value items like vehicles. Here, financing plays a substantial role in determining the total cost of an item. With the prevalence of credit used to finance almost all consumer expenditures, incorporating financing costs in inflation measures could provide a more accurate reflection of people's perception of the cost of goods. A recent study by economists from Harvard and the IMF demonstrated that reported inflation would be significantly higher if current measurements included financing costs.
The PCE measurement method, meanwhile, which policymakers focus on, is notably disconnected from the inflation experienced by the public. It only captures a little over half of what people actually pay. This disconnect is attributed to various factors, such as the exclusion of financing costs and the use of a non-price measure for owners' housing.
Additionally, roughly a third of the index includes administered prices for government-subsidized items (such as health care) or items people never pay for. The PCE index, a hybrid of market and non-market prices, is inherently ambiguous, and for it to track people's inflation would be more a matter of luck than design.
Analysts should call out the disconnect between people's and policymakers' inflation as it raises the possibility of a major policy blunder. That's because policymakers consider the current stance of monetary policy restrictive, wrongly comparing the official rate level to an inflation measure disconnected from people's inflation. However, comparing official rates to people's inflation, which includes financing costs, monetary policy remains easy—which is what the financial markets have been saying for some time.
Joseph G. Carson
AuthorMore in Author Profile »Joseph G. Carson, Former Director of Global Economic Research, Alliance Bernstein. Joseph G. Carson joined Alliance Bernstein in 2001. He oversaw the Economic Analysis team for Alliance Bernstein Fixed Income and has primary responsibility for the economic and interest-rate analysis of the US. Previously, Carson was chief economist of the Americas for UBS Warburg, where he was primarily responsible for forecasting the US economy and interest rates. From 1996 to 1999, he was chief US economist at Deutsche Bank. While there, Carson was named to the Institutional Investor All-Star Team for Fixed Income and ranked as one of Best Analysts and Economists by The Global Investor Fixed Income Survey. He began his professional career in 1977 as a staff economist for the chief economist’s office in the US Department of Commerce, where he was designated the department’s representative at the Council on Wage and Price Stability during President Carter’s voluntary wage and price guidelines program. In 1979, Carson joined General Motors as an analyst. He held a variety of roles at GM, including chief forecaster for North America and chief analyst in charge of production recommendations for the Truck Group. From 1981 to 1986, Carson served as vice president and senior economist for the Capital Markets Economics Group at Merrill Lynch. In 1986, he joined Chemical Bank; he later became its chief economist. From 1992 to 1996, Carson served as chief economist at Dean Witter, where he sat on the investment-policy and stock-selection committees. He received his BA and MA from Youngstown State University and did his PhD coursework at George Washington University. Honorary Doctorate Degree, Business Administration Youngstown State University 2016. Location: New York.
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