The Fed makes horrendous policy decisions because it does not understand inflation.
Percentage Increases Since 2022
- CPI: 13.0 Percent
- Rent: +20.1 percent
- Owners’ Equivalent Rent (OER): +19.7 Percent
- Index of Hourly Wages: +14.1 Percent
Hooray! Wages Are Up More than the CPI
Q: Really?
A: Yes but Hell No
Q: Yes for Who?
A: People who own their own home.
Q: Hell No for Who?
A: People who rent.
OER vs Rent
- OER is the price one would pay to rent their own house from themselves, unfurnished without utilities. It is a whopping 26.38 percent of the CPI.
- Rent is just what one would think, but always unfurnished without utilities to make the same comparisons. Rent is 7.50 percent of the CPI.
Q: Does anyone pay OER?
A: No silly. No one rents their own house from themselves.
People who own they own home either own it free and clear or have a mortgage. If the former, they pay property taxes, insurance, and utilities. If the latter, also add in a mortgage payment.
But mortgages, for those who have them, are fixed. They do not go up like rent. On those grounds, people who do not understand inflation, especially asset inflation including houses, believe the CPI is overstated.
Q: What about renters?
A: The BLS says rent is 7.50 percent of the CPI. But also add in OER to arrive at 33.78 percent that the BLS applies to everyone.
The problem with a 33.78 percent is many people pay far more than 33.78 percent of their income on rent.
Those who do have been clobbered by inflation. The home ownership rate is 65.7 percent making the renter share 34.3 percent.
Those who rent are also more likely to have credit card debt and student loans. Interest on credit cards is not part of the CPI. Nor are housing prices.
Is the CPI Understated?
That is what the proponents of Truflation tout. They believe inflation is only up 2.06 percent from a year ago.
Truflation does not count home prices as part of inflation, it downplays OER, and it uses measures of rent based on new leases only (about 10 percent of he market).
It’s a horribly flawed measure.
CPI Year-Over-Year Percent Change
On February 12, I noted CPI Much Hotter than Expected, Core CPI Hotter than Expected
Year-over-year the CPI is up 3.0 percent with rent up 4.6 percent.
Those who spend a huge portion of their income on rent, their own medical insurance, or student loans will scoff at the notion of 2.1 percent truflation or even 3.0 percent CPI inflation.
So will anyone looking to buy a house, many of whom have given up on the idea they will ever be able to afford one.
The Fed’s Role
Like the CPI and the ridiculous Truflation model, the Fed also ignores home prices. And when the Fed slashed interest rates to zero in the pandemic, mortgage rates fell to 3.0 percent or less.
Anyone with a mortgage refinanced putting extra money in their pocket every month to spend.
Those hoping to buy, watched home prices soar out of sight only to watch the Fed and other clueless economists say home prices don’t constitute inflation.
Two Economies
We have two economies, one for asset holders and another for non-asset holders.
It was the non-asset holders (young voters and Blacks) who switched to Trump and swung the election.
I posted that view many times in 2024, well in advance of the election.
Asset bubbles also contribute to strong spending for roughly 2/3 of the nation while the other third is in misery.
Economists like Krugman still praise the Biden economy.
Looking Ahead
I see budget deficits as far as the eye can see, and Trump will increase them.
Those budget deficits will increase inflation.
On January 23, I noted Trump “Will Demand Interest Rates Drop Immediately”
Trump repeated that call after the disastrous CPI report.
Instead, he should have blamed the Fed for cutting rates before the election.
Addendum
OER is not an approximation for those of owning their homes. A utility bill, insurance, and taxes would be a better consumer approximation because the rent portion of OER is constant for all but new home buyers, but not renters. That is how Truflation absurdly arrives at 2 percent inflation.
Regardless, the whole problem with the CPI is easy to state and hard to fix.
Inflation matters, not just consumer inflation.
Neither the CPI nor does PCE comes close to describing inflation because a huge chunk of inflation it is not in “consumer inflation”. It’s in asset prices.
The Fed does not understand this critical point, nor do economists in general.
OER is not an approximation for those of owning their homes. A utility bill and insurance and taxes would be a better approximation because the rent portion is constant for all but new buyers. That is roughly what Truflation does.
Regardless, the whole problem with the CPI is easy to state and hard to fix.
Inflation matters, not just consumer inflation.
Neither the CPI nor does PCE comes close to describing inflation because most of it is not in “consumer inflation”.
The Fed does not understand this critical point, nor do economists in general.
CPI: Utilities plus property tax plus home insurance because there is little or no competition, and cannot be manufactured in China.
What’s the purpose of: x4 OER +rent in the 34% CPI. Why ????
I disagree, Mish, and so does the Fed and most economists. The Fed cares most (and so understands) about “consumer inflation”. That’s why the meeting notes and press conferences specifically address the measurement of CPI (Consumer Price Index) and PCE (Personal Consumption Expenditures). That is what they are specifically targeting.
If you and others think ‘inflation’ should be measured and targeted differently, there are lots of other ways beside CPI and PCE to do so. Housing inflation can be measured with the Case-Schiller Index. Stock price inflation can be measured with the S&P 500 Index. Oil price inflation can be approximated with the WTI price index. Etc. We all have access to those ‘inflation’ changes.
But as we all know, all those examples are asset price indices. And agreed, the Fed is not targeting them. But why should they? Those are one-time purchases of assets, which may affect but don’t directly impact the M-o-M and Y-o-Y purchases everyday Americans make and need to be measured.
CPI and PCE have to be understated.
If the inflation measures were accurate to the real economy, inflation readings north of 10% for the past 4 (well many) years would cause employers to be on the hook to pay higher wages to attract employees and the Social Security COLA increases would decimate the program. 10 year treasury yields north of 10%? Most likely.
Good luck expecting the government to give accurate numbers.
Wow, what an insight Mish! “We have two economies, one for asset holders and another for non-asset holders.” Or said another way, the rich (asset holders) have an ok economy because their assets have gone up in value (yet they most definitely still bitch and moan about their taxes and insurance going up, and the poor (those without assets) have a shitty economy. Of course, the typical remedy to this inflation is to raise interest rates (thus making in impossible for “the poors” to ever own something they need to borrow money in order to obtain), and cut taxes, both helping “the non-poors” No wonder everyone hates economists!
And apparently the quantitative easing measurements, a causal factor for inflation along with Veblen goods, is deeply flawed now that a third of social security payments, over 500 billion yearly, according to DOGE, go to the dead still living like vampires or cyborgs into their 150s.
OK, we’ve been over all these issues ad infimum for years.
HOW SHOULD INFLATION TRACKING BE DONE?
How can the government produce a meaningful number? How do government payouts, such as Social Security get adjusted for inflation accurately?
I think the fed intentionally pushes inflation into asset or investment prices as much as possible using all their tools. Yea, some of the excess money and velocity of money pushes up consumer prices and maybe wages, but another big push is rising asset prices that are not in the CPI. I contend it’s still inflation, just not the traditional definition of rising consumer prices. It winds up being return on investment, instead of inflation in the stats. Of course whatever part of the return is inflation, they have the audacity to tax it anyway.
“I think the fed intentionally pushes inflation into asset or investment prices as much as possible using all their tools.”
Reasonable statement. The fed works for its owners and too many in the U.S. don’t know its owners are private banks. Even a site like “factcheck.org” was used in 2008 to obfuscate the notion that big banks run the show.
The establishment of the fed was pushed for by those who would benefit from it existing and those benefits continue today.
https://www.factcheck.org/2008/03/federal-reserve-bank-ownership/
“We have two economies, one for asset holders and another for non-asset holders.”
Very true, and very sad for young folks still renting. The gap keeps getting bigger.
One of the kindest moves of President Trump is to say the banks shouldn’t charge more than 10% on credit card balances. There’s absolutely no way anyone can get ahead if they’re behind on their credit card due to some misfortune like unexpected illness or car maintenance bills and then are charged 26% on the unpaid balance.
It was the non-asset holders (young voters and Blacks) who switched to Trump and swung the election.
True. And in their wise response to their misery they voted in an administration that gives even less than a hoot about non-asset holders. This economy is run by big corporations that keep increasing their size and profit margins. Just look at any table with the operating margins of the largest S&P corporations. This economy is good asset holders but not for the downtrodden MAGA crowd. And you guys think Musk and Trump care about downtrodden people? Medicaid cuts for the downtrodden, tax cuts for the billionaires is the motto of this administration. A yes, the MAGA crowd will get some crumbs: announcements of tariffs and deportation. That should keep them voting against their own interests.
“And you guys think Musk and Trump care about downtrodden people? “
YES I DO, ALBERT!
If Trump is able to get some or all of tips & SS tax cuts, that’s a lot more than crumbs, dude. Just thinking outside the box here. When was there a time in the last 40 years when the have nots prospered anywhere near the haves? I’m 57, and I don’t recall there ever being a time when the average Joe even came close to outpacing the affluent.
If there was such a time, please remind us when that was. Be that as it may, I sure as hell am glad Joe & Kamala aren’t running things anymore.
But that’s the point I am trying to make. Both parties have let monopolistic corporations run wild and billionaires get rich. It’s called legalized corruption. But Musk and Trump are the kings of legal and illegal corruption. Yes they may cut taxes on tips (which are mostly untaxed in any case). But they will keep enriching themselves at the cost of their very voters.
We can certainly agree on the corruption angle, but I’m hopeful Trump cuts into this. The corruption is a function of the overspending. Eliminate 80-90% of the overspending & the corruption will wane significantly.
“Voting against their interests” must be written somewhere in the Democrat Party playbook. Everyone has competing interests, thus one can be voting against their self interest by voting Democrat as well. California makes it law that a restaurant worker be paid X an hour minimum. Some people lose their job or have their hours cut. One small chain closed restaurants in CA to concentrate on restaurants in another state.
Not sure if it is incompetence or grievous intent to distort the actual numbers.
Mortgage is inelastic, ok. RE taxes, insurance, maintenance and utility are elastic,
especially this cold winter. Flexible utility bills and maintenance sucks renters and owners money, dampening consumption. increasing debt. What about CA and FL very elastic insurance.
Backwards
Mortgage is semi-elastic in that people will refinance if the rate goes down, but yes, the payment itself is very inelastic.
If you don’t pay utilities they get shut off – very inelastic. All you can do is lower or raise the temp of your house a few degrees, you can’t make 0 degree weather seem like 68
People don’t refinance mortgage every month or every year. If u don’t have enough equity u cannot refinance at all. Many don’t. The elastic utility bills can triple this winter. Utility co will do not shut slow payer. Utility bills, taxes and insurance will be better approximation to OER ???
Good article. The Fed’s purchases of Treasuries and MBS also heavily contributed to the 3% mortgage rates. In fact, the Fed was still buying $30B of MBS per month while home prices were rocketing higher.
In addition, the asset purchases provided huge windfall gains to the sellers of the bonds who used the proceeds to buy stocks and housing which further exacerbated unaffordability.
You were correct to point out early on that this would be an important factor in the election and it’s important to point out that the CPI isn’t adequately accounting for housing inflation.
It’s not just through fudging the CPI figures, much of the falling value of the dollar has been hidden from view by cheap imports from China, cheap illegal labor, etc.
Consider the CPI of items that can’t be imported or staffed with illegal labor: for example, college education & health care.
Look at the CPI for those items over the last 40-50 years.
Ineleastic OER north east + inelastic OER midwest + inelastic OER south + inelastic OER west plus Rent ==> BLS 34% of CPI bs.
Traditional signals for interest rates are being incorrectly interpreted and will cause a mistake by the Fed. Supply and demand market are superseding our best guesses.
Why do we measure CPI? If we measure CPI for the determination of the short term interlending bank rates (Fed Rate), then it is nothing but a statistic nightmare with deep flaws, data lags and in short too many variables. Besides banks don’t have to follow it. Right before the 2007/08 financial crisis CPI went up. Why don’t we use the 6-month treasury rate? Let the market decide. If you compare a chart to short term treasuries and the Fed rate, the short-term treasury rate determines the Fed rate, not the other way around.
Long term interest rates have been looked at as the collective thoughts on long term growth expectations and let me give you a hint that we have not been growing like we could have since 2007. People are looking at long term rates for growth and inflation expectations and seeing rates going up and expect inflation. The issue is short term market-based factors are superseding inflation expectations. We live in a bubble (US) and the rest of the world including Canada are cutting rates. The rest of the world is in disinflation and is not getting the money(dollars) they need to exist at the same level. Just like a household making minimum credit card payments, the world is treading water and raiding its piggy bank, US treasuries, to keep the house going. Long term rates are going up because foreigners are selling treasuries and treading water to stay afloat not because they are growing. Where is the world growing that is not supported by government guaranteed debt?
The average Trump voter will experience higher inflation and yet will swear that they are paying less. Manufactured reality >>>>> actual reality
“It was the non-asset holders (young voters and Blacks) who switched to Trump and swung the election.” But we are seeing the usual presidential dog and pony show: some kind of overreach on some tangent (if not opposite) projects. I surmise this means payback for elite constituencies is the real deal.
I understand your frustration that CPI is not an accurate measure for everyone (‘mileage varies’), but I disagree that the model is “deeply flawed”.
There is a specific component measurement for rent which you describe well as affecting 1/3 of households that do rent (this component does not affect me or 2/3 of the population which own a home).
But OER does give an approximation for those of us owning their homes. It is survey based which always has its complications. But if I was surveyed last year about what I think my house would rent for, I’d give a specific number. If I’m asked again this year, and I think all of the houses on my block (including my own) went up 10%, I would say my house would rent for approximately 10% more (which is more than the general CPI).
Why would/should we try to ditch those two components for the price of homes themselves? In 2024, less than 5 million homes were sold. Out of 127 million households, that is only 4% of the population. The CPI is estimated for all of us (‘mileage varies’). To base our annual housing cost increases on 4% of people making new housing purchase decisions would not be representative. 2/3 of us (homeowners) had no change in our P&I payments this past year.
OER is not an approximation for those of owning their homes. A utility bill and insurance and taxes would be a better approximation because the rent portion is constant for all but new buyers. That is roughly what Truflation does.
Regardless, the whole problem with the CPI is easy to state and hard to fix.
Inflation matters, not just consumer inflation.
Neither the CPI nor does PCE comes close to describing inflation because most of it is not in “consumer inflation”.
The Fed does not understand this critical point, nor do economists in general.
OER is an approximation of the rental value of what I’m buying or ‘consuming’ each month of my own privately owned house. The Fed is trying to measure consumer inflation month over month and year over year which obviously includes housing. But I (and millions of other homeowners) bought my house 14 years ago and may live in it for the rest of my life. So if I don’t sell my house for decades, the price of it will never be measured again, thus no inflation if the Fed used actual housing prices. So it calculates OER to approximate (and include a non-zero value) for how much my specific consumption of ‘housing’ is going up M-o-M and Y-o-Y for the decades to come. It’s not perfect, but it’s much more realistic than measuring new house prices which only 4% of the population is actually buying, and ‘consuming’ each new year
“Why would/should we try to ditch those two components for the price of homes themselves?”
Because 1/2002 to 6/2006, the Case-Shiller price index rose 58% and then from 2/2020 to 6/22, it rose 45%. During this 2002 to 2006 period, inflation average about 2.5% before peaking @ 5.5% in the middle of the Great Recession. More recently from 2020 to 2022, inflation averaged about 4% prior peaking @ 9%.
So it is abundantly clear that these two periods didn’t properly account for home prices as they should have affected inflation. Any EVERYONE knows, except you I guess, that the BLS / BLA moved away from home price pairs in 1983 to help ensure CPI was underweighted in terms of the cost of housing for the express purpose of holding down SS COLAs.
There’s absolutely NO WAY CPI has properly calculated the increase in costs associated with home inflation as well as property tax & homeowner’s inflation.
I think you’re confused. Which Fed chair told you his goal was to “properly account for home prices”? And how are you defining “home & homeowner’s inflation”? I bought my home 14 years ago. The P&I payment of my mortgage (which is a huge part of my total monthly and annual consumer expenditures) has not changed one cent during that time period (so 0% inflation for me). Same for millions of homeowners across the country.
The Fed’s decades-long calculation of CPI include specific rent measurements and OER to therefore approximate those components of housing “inflation” which comprises part of everything you and I buy
I’m far from confused while “suggesting” that using a survey vs real data is moronic. Therefore, for decades since 1983, CPI has been categorically underreported, but there’s ZERO that can be done about it.
So basically, we’re just yammering back & forth.
Savings aren’t synonymous with the money supply. It is much more desirable to promote prosperity by inducing a smoother and continuous flow of monetary savings into real investment outlets than to rely, as we have done since 1965, on a vast expansion of commercial and Reserve bank credit (with accompanying inflation) to stimulate production.
Lending by the banks is inflationary (increases the volume and turnover of new money). Lending by the nonbanks is noninflationary (results in the turnover of existing money, a velocity relationship). If savings are not expeditiously activated, then a dampening effect is generated.
Prof. Werner brilliantly explains how the banking system and financial sector really work.
The US Golden Age in Capitalism was where small savings were pooled, expeditiously activated, and put back to work. I.e., the intermediaries, the nonbanks (backstopped by the FSLIC, NCUA etc._, grew much faster than the banks (making the bankers jealous, driving up Reg. Q ceilings). Economist John O’Donnell posited that velocity financed 2/3 of the economy whereas today, money finances all of the economy. The nonbanks, the thrifts, largely invested in targeted real investment outlets (residential real estate). That resulted in a demand for both labor and materials.
….and we all know that the FED KNOWS that the CPI IS bullshit and they clearly know that they are lying about it.
Ethics and Morality are not considered an ingredient to running the numbers.
Whether a mouse trap is a good mouse trap depends on what you want to catch. The CPI is designed to catch the cost of consumption of a representative household unit, and therefore, by design, it should not try to catch the (usually large) fluctuations in the prices of assets like houses. That said, the CPI should reflect the cost of services that can be derived from assets like houses. I think it would be serious nonsense if the Fed would start targeting the Case-Shiller house price index. Asset prices reflect expected discounted streams of income, and, as such, are supposed to fluctuate wildly in response to small changes in expected incomes and/or discount rates.
Asset prices are based upon loan collateral. The payment of interest on interbank demand deposits suppresses long-term interest rates.
What does that mean?
Asset prices are jointly determined by those with a demand and supply of the assets. Loan collateral makes very little demand/supply difference, but interest rates changing can significantly change both supply and demand – and thus indirectly asset prices
I read that reducing the Federal government workforce by 20 percent would lead to just a one percent decrease in the Federal budget. If true, then all of this cutting (much of which will be overturned – or reversed when people see how it affects them) is just smoke and mirrors.
Cutting the military expenses would do more. A measure that would be highly effective (but would never pass) is to stop paying for every possible medical operation and treatment for those over 75 (note: includes me). Doctors and hospitals have no incentive not to provide expensive medical care for those who have limited years left. (I know, everyone wants to live forever and many families will do CPR on a corpse if there is the slightly chance of generating a breath of life). But this idea gets mixed up with the goals of the medical insurance industry to deny care whenever they can get away with it. What a mess our system is.
What are Government employees engaged in?
A: Spending taxpayers monies.
B: Compliance with regulations
Cutting Government employment numbers means fewer people involved in promoting Spending and Regulation.
This is a good thing.
No shedding of tears by many for those who now find themselves needing to become Gainfully employed.
Welcome to life, where jobs are there because services are needed. When services are no longer needed that is an opportunity to expand ones horizon.
Right, headcount reductions have to be part of the equation and most likely are the easiest to determine out of everything to be looked at. And departments can eventually rehire people, if reductions go too far. Finding the big waste in SS, Medicare & DoD are all going to be vastly more challenging, especially when it comes to actually implementing cuts.
We’re less than a month into this, and everyone (including myself) is playing armchair quarterback.
People, let’s give this more time to flesh out.
San Mateo county in California passed a law a year or so ago that no person whose job is supplanted by AI can be laid off!
Government does not want its kingdom of workers made obsolete by technology as government jobs are how politicians reward their voters.
Notwithstanding anything else you said, I’d be willing to have only a “Sudden & Accidental” limited health care plan (no cancer, no diabetes, no old knees, no old hips, etc.), whether its from a private individual plan, employer or government. But that’s just me, YMMV.
The federal government right now spends $7.3 trillion. The federal civil wage bill is $.4 trillion, and it is one of the slowest growing components of federal spending. The problem is all concentrated in health care spending, social security, and the military. What Musk is doing is a classic case of putting the cart in front of the horse.
How can you say this, when DOGE hasn’t completed a full audit of any of these three largest spending categories?
Are they just supposed to not look for crazy, out of control spending or making recommendations on headcount reductions?
These aren’t mutually exclusive, Albert.
We never will. The purpose wasn’t cost savings, it was stopping investigations against me and my companies.
The “audits” for these entities are over.
I know, spending on nuclear security personnel is completely out of control.
Yes, that seems to be a new talking point being made by the liberals.
And yet, when we look at local budgets and teachers, it is often said that salaries and benefits make up 70-80% of costs.
So who is lying?
“local budgets and teachers” are not paid through the federal budget, so maybe nobody is lying; and you are just confounding two different things
You have stated on a number of occasions that we need a new paradigm as applied to the Federal Reserve. I would like you to present a piece that describes that position. For example, what current Fed responsibilities should be maintained while we move to a market-based rate structure?
As for inflation, what are you thinking?
I know these are theoretical questions but let’s start somewhere. Perhaps the dialogue will attract others and we can transition to a better world. It will no doubt be painful.
There are no Paul Volckers in sight!
– The Fed makes horrendous policy decisions because it does not understand inflation.
> Or, they make policy decisions, with forethought into how it will be utilized by those they created it for. How it will go against what they don’t want, but provides to those what they do? I sense determination in the decision making.
– Hooray! Wages Are Up More than the CPI
> What they want you to see right now. As their wants change, so does the equation… what you want is irrelevant.
– Is the CPI Understated?
> Yes, “IF” it needs to be. No, “IF” it doesn’t.
– It’s a horribly flawed measure.
> Or, is it a measurement done exactly “HOW” they want it done, and with the proper outcome to support their needs, and wants as a result, “This Time”?
– Two Economies: We have two economies, one for asset holders and another for non-asset holders.
> Has it not been this way for several decades? I have been on both sides of the coin, on several instances, due to life circumstances. I have felt the joy of being an asset holder, and the doors that can open for you. I have also been on the other side, due to opening up every door, because of youth and stupidity. I adjusted multiple times, but quickly realized what you State Above. One must realize this, how to work within it, and quickly.
– It was the non-asset holders (young voters and Blacks) who switched to Trump and swung the election.
> They are being promised what all people deserve, and that “Honesty and a Fighting Chance”. Most when given that, come out on top, but stuck with Lies, and No Chance, you often drown, as this Country has been doing under the Democrats!!!
– I see budget deficits.
> As do I.
>> I also see a lot of clawed back, and yet unspent money coming back from all over the place. Perhaps that can alleviate some of the pressure? I see still many more cuts to come as well, so that should help as well. Going to be a tough “First Year” for sure…
re :”Has it not been this way for several decades?”
No, The housing crisis was deliberate. Bernanke, pg. 287 in his book “The Courage to Act”, “Lower long-term rates also tend to raise asset prices, including house and stock prices, which, by making people feel wealthier, tends to stimulate consumer spending”-the “wealth effect”.
Bernanke: “Easier monetary policy, for example, raises stock prices. Higher stock prices increase the wealth of households, prompting consumers to spend more–a result known as the wealth effect. Moreover, high stock prices effectively reduce the cost of capital for firms, stimulating increased capital investment. Increases in both types of spending–consumer spending and business spending–tend to stimulate the economy.”
Remunerating interbank demand deposits artificially lowers interest rates and stokes asset prices.
– No, The housing crisis was deliberate.
> Think about what you said there? The “Wealth Effect” as you refer to, happens all the time. It’s called the business cycle or ups and downs, or a host of other references. Nobody forced people to buy Homes, or anything else for that matter.
– “Lower long-term rates” also tend to raise asset prices.
> Wrong again, as it’s the “Cost To Borrow” that tends to raise asset prices. Yes, it includes houses, cars, stocks, bonds, etc.
Think of it this way: The Less it cost, the More you can Borrow and therefore Spend!!!
The rest is simply noise…
“Instead, he should have blamed the Fed for cutting rates before the election.”
Agreed. I have come to believe IMHO that the Fed cut in Nov & Dec to appease Trump. Otherwise, there was absolutely zero economic reason to do so other than to reduce real interest rates. CPI was rising while GDP & employment were both holding very steady. If Trump is able to follow through with downsizing the government through what basically will be impoundment and headcount reductions, the question becomes will this to be enough to slow the economy late this year?