Introducing

Joseph G. Carson

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.

Publications by Joseph G. Carson

• USA| Apr 11 2022

  Investors Beware: Decades-High Profit Margins Will Fall Hard As Inflation Cycle Ends

  Investors should brace for a sharp drop in nonfinancial companies' profit margins as the Federal Reserve raises official rates and shrinks its balance sheet significantly to reduce inflation. History shows that the unwind of inflation cycles tends to trigger an abrupt and sharp adjustment in margins as prices fail to cover overall costs.

  According to the GDP data, real profits margins of 15.3% in 2021 for nonfinancial companies were the highest since the mid-1960s. The significant increase in profits margins, up 2.3 percentage points over the prior year, shows that firms passed their higher costs for materials, supplies, and labor to the end customer. Yet, the inflation cycle's flip side shows that margins get squeezed.

  The last time the Fed faced an inflation cycle as large as the current one and expressed an explicit commitment to reduce it and achieve price stability was in the early 1980s (the Volcker war on inflation era).

  On the surface, today's inflation rate looks less threatening than that of the early 1980s. The current one is more than a year old, while that of the early 1980s was a spillover from the high inflation rates of the late 1970s. Yet, if measured using the same methodology of the early 1980s, today's consumer price inflation rate is as high. Meanwhile, the producer prices for all three processing stages, finished, intermediate, and crude, are significantly higher.

  So what matters more for reversing an inflation cycle; the length of the price cycle or the scale and breadth? Policymakers should presume all three matter, and it will take a significant increase in policy rates and luck to break the current cycle.

  Price cycles are uneven on the way up and equally, if not more so when the process reverses. Policymakers' projection of a miraculous slowing in inflation to its 2% price target (i.e., roughly a 600 basis drop in the reported consumer price inflation rate) and not triggering destabilizing effects in the economy and labor markets is not credible.

  Significant and sharp drops in inflation rates trigger sharp declines in operating profit margins as firms' consolidated costs do not fall as quickly. For example, in the early 1980s, operating profits margins contracted by 400 basis points, and other periods showed even more significant margins decline.

  The reversal in the current inflation cycle will not require as big of a policy adjustment as in the early 1980s. Still, the counter to that is that the labor markets are much tighter, limiting how quickly the firms can control their overall consolidated cost structure. As a result, it would not be a surprise that at the end of this process, firms operating profits experienced a decline equal to that of the early 1980s.

  Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

  by:Joseph G. Carson

  |in:Viewpoints
• USA| Mar 24 2022

  SNL Fireside Chat With Paul Volcker and Jerome Powell

  Saturday Night Live (SNL) held a fireside chat with Former Fed Chairman Paul Volcker and current Fed Chair Jerome Powell. Here's a replay of their conversation.

  Fed Powell. It is an honor to be on the same stage with you. I think of you as one of the greatest public servants in the history of the Federal Reserve.

  Paul Volcker. Thank you. Those are very kind words. How goes it at the Fed nowadays.

  Powell. Well, we have a little inflation problem.

  Volcker. How bad is it?

  Powell. Consumer prices (CPI) have risen 7.9% in the past year. But at the Fed, we focus on the personal consumption expenditure (PCE) deflator, which has only increased 6.1%.

  Volcker. Why does the Fed look at the PCE and not the CPI? The CPI is what people pay for things, and the PCE includes a lot of non-market prices.

  Powell. That is true, but increases in the PCE run less than CPI, making it look like inflation is less high and harmful. The Fed is in the game of trying to influence expectations, so we picked the lower number of the two.

  Volcker. Selecting a price measure simply because it produces a lower inflation rate is not sound monetary policy. Good policy decisions flow from unbiased and accurate statistical information.

  Powell. That is fair. But we are in the business of managing people's expectations so picking an index with a lower number helps.

  Volcker. What is this rental equivalence that has replaced house prices in the measures of inflation?

  Powell. It is supposed to measure what people can rent their house for if they decide to rent.

  Volcker. How is that inflation? The definition of inflation is what people pay for things.

  Powell. I know. But rental equivalence makes reported consumer price inflation rise less fast when there is rapid house price inflation, and that makes it appear that the Fed is doing a good job. Remember, it's our job to try to manage people's inflation expectations.

  Volcker. But people know inflation when they see it. Nowadays, people have more sources of house prices than they did in the 1970s, so actual inflation or experienced inflation must be much higher. So how much higher would reported inflation be if the CPI were measured similarly to the 1970s?

  Powell. Based on press reports, it would be double-digit inflation, equal to the highs of the 1970s.

  Volcker. Based on press reports? Doesn't the Fed staff know?

  Powell. No. If we don't calculate it, we can overlook it and make it appear that things are always better than they are. Remember, it is our job to try to manage people's inflation expectations.

  Volcker. That's a section of monetary policy I never read or learned. So what are the critical drivers or sources of this inflation nowadays?

  Powell. Most of the increase in inflation is due to supply shortages and bottlenecks emanating from the pandemic. But in recent months, inflation has broadened.

  Volcker. I thought the Fed has consistently argued that inflation is always and everywhere a monetary phenomenon. How fast have monetary aggregates been expanding.?

  Powell. We don't look at money nowadays.

  Volcker. The Fed is in the business of making money.

  Powell. That is true.

  Volcker. So how fast?

  Powell. Broad money has increased by over 40% in the past two years.

  Volcker. How much?

  Powell. 40%.

  Volcker. Uh-oh! And the Fed is surprised by the surge in inflation?

  Powell. We are committed to fighting inflation and plan to front-load official rate increases.

  Volcker. Front-load? What do you mean by front-loading?

  Powell. Policymakers see the Fed funds rate at 1.9% at the end of 2022 and 2.8% at 2023. So we plan to hit those targets earlier.

  Volcker. When I was Fed Chair, front-loading involved lifting official rates before consumer prices surged. It seems to me the Fed is back-loading rate increases, trying to catch up to inflation.

  Powell. Remember, it is our job to try to manage people's inflation expectations. So far, people and investors still think we are doing a good job.

  Volcker. The pendulum of central banking has fundamentally changed, moving away from things it can control and basing policy success on influencing people's expectations. How did the Fed fall into the trap of assigning so much weight to people's expectations and not actual statistics?

  Powell. I hope history will show that we are committed to price stability as much as you were. But, remember, we are judged by a different standard---people's expectations (although no one knows how to measure them)--and not actual inflation.

  Volcker. I wish someone could give me one shred of neutral evidence that inflation expectations lead to actual inflation and not that persistent inflation leads to higher expectations.

  Powell. When facts change, I will retire my views. Thank you.

  Note. Paul Volcker passed away on December 8, 2019. So his responses are my words of what I think he would say today.

  Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

  by:Joseph G. Carson

  |in:Viewpoints
• USA| Mar 21 2022

  The Fed's Biggest Inflation Problem: Record Surge in Equity Asset Prices

  The Fed finally admits it has an inflation problem. Yet, what is the bigger inflation problem and potentially more destabilizing to the economy as it unwinds? Is it the 40-year high in consumer price inflation, or is it the surge and record valuations of asset prices? Of course, policymakers would say it's consumer price inflation. However, I would argue its asset prices since easy money has fueled a record surge in equity prices, lifting macro valuations far above the dot.com bubble.

  Asset inflation has been a dominant feature of business cycles for the past two decades or more. And, over the past two years, helped by an avalanche of liquidity as the Fed doubled its asset balance sheet to $8.5 trillion, the market valuation of domestic equities to nominal GDP (i.e., the Buffett Indicator) has jumped to levels never thought possible. At the end of 2021, the market value of domestic equities to nominal GDP stood at 2.55.

  It is worth noting that before the pandemic, the Buffett Indicator hit a record high at the end of 2019, surpassing the peak level of the dot.com bubble. In other words, the Fed's easy money policies that resulted in an over-valuation of equities at the end of 2019 created a mind-boggling extreme over-valuation at the end of 2021.

  To put the equity market's valuation in perspective, if equity prices dropped 25% in 2022, or a decline four times bigger than the decline in the S&P 500 to date, that would only bring the Buffet Indicator back to the peak of the dot.com bubble. And a drop of nearly double that scale to bring it to the average of the past two decades.

  Before the last two years, history shows several years of negative returns following periods of extreme overvaluation. Yet, the S&P equity index has jumped nearly 50% over the past two years, while the Nasdaq is up over 80%. So instead of correcting in value, the equity market moved into a new orbit of over-valuation.

  If there are laws of gravity in finance, the equity market is in for a big hurt. That's because monetary policy is a blunt instrument. As policymakers use traditional and non-traditional monetary policy tools to kill the consumer price inflation cycle, it will hit asset prices hard. Moreover, given the scale of over-valuation, the potential decline in equity prices could rival the "big" ones of years past. So investors should take note: history sometimes repeats itself in the world of finance.

  Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

  by:Joseph G. Carson

  |in:Viewpoints
• USA| Mar 10 2022

  Fed's Decision: "Go Slow" or "Go Bold"?

  In the movie "Draft Day," Kevin Costner, the GM of the Cleveland Browns, tells a stunned GM of the Seattle Seahawks of a last-minute trade involving current and prospective draft picks that Seattle got from Cleveland only a few days ago "We live in a different world than we did just 30 seconds ago." The Fed also lives in a different world than just 30 or 60 days ago, meaning what many Fed officials thought would be the appropriate policy stance when they exited the January 25-26 FOMC meeting is no longer adequate or sufficient at the March 15-16 meeting.

  At the press conference following the January FOMC meeting, Federal Reserve Chair Jerome Powell stated, "it will soon be appropriate to raise the target for the federal funds rate." Since that meeting, most policymakers have hinted that they would support a 25 basis points hike in the federal funds rate at the March meeting.

  Yet, a 25 basis points hike in the federal funds rate would result in the real federal funds rate being lower in March than it was estimated to be in January. The reason is that reported consumer price inflation is markedly higher. To be sure, the reported twelve-month change in the consumer price index at the January meeting was 7%, and now through February 2022, it's almost 100 basis points higher at 7.9%.

  At next week's FOMC meeting, will policymakers adopt a "go slow" or a "go bold" strategy? Betting odds indicate a "go slow" approach. Yet, if policymakers want to change the narrative and regain credibility on fighting inflation, "go bold" would be a better decision.

  Ideally, a "go bold" strategy would start with a 50 basis point hike and end the promise that official rate increases would be gradual, modest in scale, and only occur at regularly scheduled meetings. Breaking the inflation cycle and inflation psychology requires bold moves.

  In 1994, former Fed Chair Alan Greenspan stated, "If the Federal Reserve waits until actual inflation worsens, it would have waited too long." Policymakers have waited too long, and it's now incumbent on them to move quickly and limit the downside risks to the economy that have accompanied every inflation cycle of the past 60 years.

  Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

  by:Joseph G. Carson

  |in:Viewpoints
• USA| Mar 01 2022

  Manufacturer's Buying Policy Signal Firms Are Expecting Persistent Inflation

  In February, the Institute of Supply Management (ISM) reported that the lead time for capital expenditures, production materials, and maintenance and repair supplies hit record levels. Lead times for CAPEX jumped six days to 173 days, materials two days to 97, and maintenance four days to 50.

  Leadtimes are a valuable indicator of current and future demand. When backlogs rise and get stretched out, firms protect their production schedules by building safety stocks and placing long-dated orders for materials and supplies to meet expected future demand.

  The current generation of policymakers probably does not follow lead times, but the old generation did. (Read the 1994 transcripts of the Federal Open Market Committee meetings). Former Federal Reserve Chairman Alan Greenspan religiously tracked lead times, order backlogs, and delayed deliveries (i.e., vendor performance or supplier delivery index) as signs of future inflation and inventory building. The latter is an essential part of demand-driven fast growth and inflation cycles since it adds a layer of demand, putting more pressure on prices.

  In February, the customer inventories index stood at 31%, with 16 industries reporting too low and none reporting too high. The ISM report indicated that February marked the 19th consecutive month customer inventories were at historically low levels. The prices paid index of 75.6% remains relatively high, and 17 industries reported paying more for raw materials and none paying less.

  In 1994, with a set of lead time, suppliers index, and price paid data that is not as scary as today, the old generation of policymakers saw the need for substantial monetary restraint to break the inflation cycle and limit the cyclical rise in general inflation. That policy playbook worked as pipeline price pressures never reached the consumer level.

  It's too late for the current generation of policymakers to follow the 1994 playbook as pipeline price pressures are present at the consumer level, with more to come. Yet, policymakers can make things worse by not acting quickly and aggressively. Russia's invasion of Ukraine complicates the timing of monetary policy adjustment, not the scale, as the stance of monetary policy remains far too easy to break the inflation cycle.

  Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

  by:Joseph G. Carson

  |in:Viewpoints
• USA| Feb 22 2022

  The Fed's Problem: "It's All About The Money"

  The Fed has a problem. It's in the business of creating money, but it formulates monetary policy without regard to money itself. So in times when its policy decisions produced a record surge in broad money, policymakers are not attentive or alerted to the negative (inflation) consequences.

  From February 2020 to the end of 2021, broad money increased by $6.5 trillion or over 40%. That increase over less than two years is roughly equivalent to the rise over the previous ten years. Yet, policymakers who have long argued that "inflation is always and everywhere a monetary phenomenon" called the surge in inflation transitory, owing to supply bottlenecks. Had policymakers still recognized money as a potential source of inflation, it would not be in the pickle that they find themselves today.

  Policymakers now face the unprecedented challenge of dealing with consumer and producer inflation and elevated asset prices ( possibly bubbles.) Policymakers' record on reversing inflation cycles and recognizing asset bubbles is lousy. Policy adjustments have always been late (except for Greenspan's 1994 preemptive strike), resulting in awful economic and financial outcomes, some much worse than others.

  As bad as policy decisions were in the past year, it is reckless that policymakers are still easing policy today. Publically saying the monetary policy is "wrong-footed" but not doing anything until the next policy meeting, a month away, is like saying we want the fire to burn some more before being compelled to distinguish it.

  Before the preemptive strike against emerging inflation pressures in 1994, Fed Chair Alan Greenspan stated in his semi-annual monetary policy testimony, " if the Federal Reserve waits until actual inflation worsens, they would have waited far too long." It's too late to use Mr. Greenspan's playbook, but policymakers still need to act swiftly. Some policymakers have argued that only a modest adjustment in official rates is needed because of well-anchored inflation expectations. That is short-sighted and wrong. Actual or realized inflation leads to changes in inflation expectations, not the other way around. Persistent inflation will increase inflation expectations over time.

  Several decades ago, the Bureau of Economic Analysis (BEA) created the monetary and financial flow index (MFF). It consisted of the growth in broad money (adjusted for inflation), change in business and consumer credit, and liquid assets. BEA stopped publishing this series in the early 1990s, and I recreated the series with assistance from BEA, plus updating the series for new financial instruments, such as new flows into bond and equity funds.

  The MFF index was a helpful gauge to predict the peaks and troughs of economic growth cycles and pinpoint excess liquidity situations. The MFF index signaled excessive liquidity growth ( i.e., well above GDP) before the dot.com and housing bubbles. The primary source was explosive private sector credit growth and robust gains in liquid assets.

  Over the past year, growth in the MMF index has been more than twice that of dot.com and housing bubbles, owing to record growth in broad money and bank credit. Too much liquidity is the fuel for inflation.

  The Fed started this inflation fire by creating too much money. Now, it has to produce less. In January 2022, broad money is up roughly 14% in the past year, down from 25% a year earlier, but still far too fast to kill the inflation dragon. Policymakers have to curtail money growth to a rate well below nominal GDP. That will require a substantial increase in official rates and a sizeable shrinkage in the balance sheet.

  Removal of liquidity will appear in asset prices, financial ones before tangible, long before it shows up in conventional measures of inflation. Mr. Market, the biggest beneficiary of Powell and company liquidity bonanza, will soon cry about too little liquidity. Investors forewarned.

  Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

  by:Joseph G. Carson

  |in:Viewpoints
• Global| Jan 11 2022

  Blunders By Fed Spells Trouble For Risk-Assets

  Try to recall a period when the Fed has misjudged inflation and labor market dynamics as poorly as they have in the past year. The Fed initially called the inflation jump "transitory," only to back away from that assessment when it continued to move higher and broaden. Consumer price inflation will end the year near 7%, the highest in several decades. At the same time, despite growing evidence of labor shortages, the Fed continued to argue it still did not meet its full employment mandate. If an unemployment rate of 3.9% at year-end, down nearly 300 basis points in a year, and a 5.8% increase in average wages for non-supervisory workers, the highest jump in several decades, is not evidence of an economy well-beyond full employment, then what is it?

  Never before has the Fed continued to ease policy in the face of sharp increases in prices and wages. As flawed as the current monetary policy stance is nowadays, the more significant issue is how policymakers undo the past year's mistakes. Because of adhering to rigid rules of communicating a policy change well before and only at regularly scheduled meetings, policymakers cannot lift official rates for a few more months. Being late on rate adjustments suggests that modest policy steps to contain inflation and emerging imbalances would not be enough. Uncertainty over monetary policy spells trouble for the economy and deepens the downside for risk-assets.

  A few weeks ago, Randall Forsyth, Associate Editor, Up & Down Wall Street columnist at Barron's, interviewed Mr. Felix Zulauf, a longtime member of the Barron's Roundtable. Mr. Zulauf expects a sharp drop in the S&P 500, falling to 3000, as "the markets are about to be slammed by a reversal of the extraordinary fiscal and monetary stimulus applied to fight the pandemic. While policies remain loose, what counts is the change in, rather than the absolute level of, stimulus.

  Mr. Zulauf did not offer a forecast for fed funds, Yet, history shows that it requires a fed funds rate above consumer price inflation to reverse or stop inflation cycles. That does not mean the Fed needs to raise rates equal to peak inflation. Policymakers are more concerned about persistent inflation, running well ahead of its 2% target. Suppose we assume roughly half the rise in consumer price inflation in 2021 is pandemic-driven, probably an overly generous assumption. In that case, that still results in an underlying inflation rate in the 3.5% to 4% range and a policy rate of equal scale. Yet, policy rates might never reach that scale as it would trigger declines in asset prices similar to or greater than Mr. Zulauf's forecasts.

  Mr. Zulauf did not offer any timeline for the sharp drop in equity prices. But he felt the sharp decline would "shake authorities," forcing them to stop and reverse course at some point. An equally bullish view follows Mr. Zulauf's bearish outlook. He believes the Fed will turn on the monetary spigots again, triggering a rally in the S&P 500 to 6000. A u-turn of that magnitude is not a 2022 event.

  In my view, with the market valuation of equities trading 2X times GDP, above the tech-bubble levels, risk assets are most vulnerable to a rapid change in Fed policy. An increase in official rates spells trouble for equities, and a decision to shrink the balance sheet at some point would be doubly bad as the latter would lift long-term rates and reduce the present value of future cash flow. Blunders by the Fed in 2021 come with a cost---higher rates, increased volatility, and sharply lower equity prices in 2022.

  Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

  by:Joseph G. Carson

  |in:Viewpoints
• USA| Dec 16 2021

  What Is Maximum Employment? Whatever It Is The Current Labor Market Is Well Beyond Maximum

  Having erred in calling the inflation surge transitory, the Fed appears to be making another error in assessing the labor market. The official statement following the December 14-15 FOMC meeting stated that "the Committee expects it will be appropriate to maintain this target range (i.e., on official rates) until labor market conditions have reached levels consistent with the Committee assessments of maximum employment.

  What is maximum employment? Maximum employment is a level of employment and joblessness that strikes a healthy balance between demand and supply of labor, resulting in moderate wage increases. The current employment situation is anything but balanced.

  November's unemployment rate of 4.2% is 1.8 percentage points below March. The last time the jobless rate starting at 6% fell as much as it did since March was 1950---over 70 years ago. Yet, after that record fall, there are 11 million job openings, 4 million more than the unemployed. Moreover, a record number of small businesses can't find qualified workers, and a record number are planning wage increases.

  Average hourly earnings have increased 5.9% in the past year. Workers are demanding more, and companies are rushing to meet those demands by hiking wages and bonuses and promising more.

  Labor markets have far passed the point of demand and supply balance. And by not recognizing the tightness of labor markets, the Fed is fueling a faster wage cycle and a different source of inflation.

  Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

  by:Joseph G. Carson

  |in:Viewpoints
• USA| Dec 13 2021

  The Next Catalyst for Inflation: Significant and Persistent Increases in Labor Costs

  Significant and persistent increases in labor costs could be the next big surprise in the inflation cycle. My research found that the most reliable signal on the labor market is the monthly change in the civilian unemployment rate. Since the spring, the record drop in the civilian unemployment rate indicates that the labor markets have far passed the point of demand and supply balance. That will force companies to continue increasing pay to maintain workers and attract new ones.

  November's unemployment rate of 4.2% is 1.8 percentage points below March. Over that period, the jobless rate recorded monthly declines of 0.4 percentage points or more three times. Monthly drops in the jobless rate of 0.4 percentage points or more are rare. It's even rarer to occur when the jobless rate is at or below 6%. It happened four times in the past 50 years, and three of those occurred since March. Also, the last time the jobless rate starting at 6% fell as much as it did in 2021 was 1950---over 70 years ago.

  Press reports indicate that companies plan the most significant wage increases in 2022 in over a decade. Yet, with job openings at 11 million and exceeding the number of unemployed by 4 million, the odds are high that wage costs will surprise as much on the upside as commodity and freight costs did in 2021.

  A few months ago, large companies, such as Walmart, Costco, and Amazon, announced pay increases and significant pay incentives for workers to stay with the firm in 2022. At those announcements, the jobless rate was around 5%; there is even more pressure now, with the jobless rate approaching 4%. The most severe pressure is likely to be felt in smaller companies (100 or fewer workers) since losing a handful of workers will force others to work longer hours, demanding more pay in the process.

  Average hourly earnings have increased 5.9% in the past year but still, trail inflation by 100 basis points. Workers want more. Wage increases have not exceeded consumer price inflation for an extended period since the late 1990s. But, the balance of power between labor and employers has shifted, and faster wage increases are in store for 2022.

  So far, the current inflation cycle has been more significant and broader than expected. Despite its scale and persistency, many are forecasting an end to the inflation cycle, citing stable to lower oil prices and easing freight and shipping costs. Yet, that optimistic view contradicts the lessons learned from the 1970s inflation cycles and the political trade-off at the Fed of fighting inflation at the expense of jobs and wages.

  Supply-side factors, impacting a wide range of agricultural and industrial commodities, sparked the 1970s inflation cycle. That is similar to what sparked the current inflation cycle. But, years of easy money and expansive fiscal policy extended the 1970s inflation cycle.

  Fed policy nowadays is more accommodative than the entire decade of the 1970s. At the same time, the federal government appropriated a record $5.6 trillion in spending (roughly 25% of GDP) over the past two years, with the White House hoping Congress will pass another round of stimulus before year-end. In the 1970s, fiscal stimulus was a fraction of that.

  With that monetary and fiscal accommodation scale, it makes more sense to look for reasons the inflation cycle will live instead of dying on its own. Surprised by the 2021 inflation cycle, policymakers and many analysts appear to be making the same mistake by ignoring the factors that could sustain the inflation cycle in 2022.

  Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

  by:Joseph G. Carson

  |in:Viewpoints
• Global| Aug 10 2021

  Inflation Bombshell: A Market-Based PCE House Rent Measure May Be Coming

  The Bureau of Economic Analysis (BEA) is researching the shortcomings of the owner's rent price index it gets from the Bureau of Labor Statistics (BLS) consumer price index as it plans to change its source data for housing services in the GDP accounts. Shifting to a market-based measure of owners' rents in the PCE inflation measure would be an inflation bombshell.

  Assuming everything else equal, a market-based measure of owners' rents would permanently lift the PCE inflation, especially during expansions and the dwindling supply of homes for rent, and put an end to the Fed's elusive chase for 2% inflation. The level of official rates would be markedly higher and sit above inflation rather than below. Could a simple change in the measurement of reported inflation end the decades-long bull market in bonds and equities?

  Owners Housing Costs

  In its May Survey of Current Business, BEA announced that it planned to include a new current dollar estimate for housing services as part of the annual update to the GDP accounts, using data from the American Community Survey. The article stated that the revisions would affect the current dollar estimates and would not affect the deflators for PCE housing services as they planned to continue to use the CPI rental equivalence measure.

  BEA has a dual responsibility, providing an accurate estimation, as best possible, of the nominal and real output values. So, I asked a senior official at BEA why they didn't move away from the CPI measure of owners' rent. Using an improper price deflator for owner-housing would over-state the real value of housing services during cyclical upturns and understate PCE inflation.

  The senior official responded, "We are currently in the process of researching possible shortcomings of the current rental equivalence price." Saying they are investigating the issue does not mean a change is coming. But in the nearly two decades of researching and writing about how the CPI understates housing inflation, this is the first time a senior official from a government statistical agency (BEA or BLS) stated to me that they were looking into the issue. Progress?

  I shared with BEA the research that I presented in 2005 at a panel session, "Housing Costs in the CPI: What Are We Measuring?" at the National Association of Business Economists Annual Meeting in Chicago. The CPI rent index could be statistically explained with a high degree of accuracy by four factors; the vacancy rate in the rental market, the ratio of the vacancy rates in the rental and owners markets, construction cost inflation, and the change in house prices. Of the four, the vacancy rate is the most critical driver of the change in rents.

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  Employing the same approach but replacing the vacancy rate of the rental market with that of the owner market help create an estimated implicit rent for owner-occupied housing. The estimated implicit rent index tracked the BLS series, but a significant divergence appeared when BLS stopped sampling the owners market in 1998. And during the housing cycle of the 2000s, the estimated implicit rent ran considerably faster than the official BLS series; in other words, the change in sampling led to an understatement of CPI and PCE inflation from what would have occurred had the change not been made.

  BLS, in its presentation, agreed "that the rental-vacancy rates influence rents, but that it is not clear how the owner-vacancy rate influences the cost of shelter services for owners." Common sense would tell you that if the vacancy rate is essential in one market, it is equally significant in the other. And it is the relative shift in vacancy rates that drive different rent patterns. Suppose the vacancy rate is declining in the owner's market while stagnant or rising in the tenant market. In that case, one will expect the rental rate in owner housing to be increasing relative to the tenant market. But for the past two decades, the CPI rent series shows the opposite tenant's rents rise faster than owners even with higher vacancy rates.

  A market-based measure of owner-occupied rents would have zero effect on the economy. But there would be spillover effects on the economy and finance as policymakers respond to a permanently higher reported PCE inflation rate. That's because the days of monetary policy trying to achieve a 2% inflation rate would be over and replaced by policymakers attempting to limit the cyclical uptick in inflation. The transition would not be seamless, and the payback in finance could be significant as higher reported inflation increases volatility and risks. Stay tuned.

  Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

  by:Joseph G. Carson

  |in:Viewpoints
• Global| Jun 23 2021

  Inflation Cycles Create Their Own Sustainability

  What many are missing about price cycles is that they create sustainability of their own. Higher prices generate revenue and income, creating more demand and more revenue and income. Price cycles don't die out; they spread and develop [...]

  by:Joseph G. Carson

  |in:Economy in Brief
• Global| Jun 17 2021

  Fed Is Promoting A Public Perception of Inflation That Is False--- Fed Admits It In New Forecasts

  The Federal Reserve continues to claim that the current run-up in consumer price inflation is "transitory," pushed higher due to base effects and a temporary burst in pent-up demand as the economy re-opens. Yet, that view is in direct [...]

  by:Joseph G. Carson

  |in:Viewpoints