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Three Measures of Inflation are All Running Hot

Let's compare the PCE, the Fed's preferred measure of inflation to the CPI and an alternate measure that I compute.
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Three Measures of Infation 2021-08

Three Measures Year-Over-Year

  • PCE: 4.26% August
  • CPI: 5.25% August
  • CSAI: 8.82% July


  • PCE: Personal Consumption Expenditures. It differs from the CPI in that it includes prices paid on behalf of consumers such as Medicare and Medicaid. It does not directly include home prices and it underweights rent and overweights medical expenses compared to the CPI. The PCE is calculated by the BEA, the Bureau of Economic Analysis.
  • CPI: Consumer Price Index. This is the standard measure of alleged consumer prices. As with the PCE, the CPI does not factor in housing prices. The largest component of the CPI is Owner's Equivalent Rent (OER), a fictional price that consumers would pay to rent their own house from themselves, unfurnished and without actual utilities. OER makes up a whopping 24.26% of the CPI. The Bureau of Labor Statistics (BLS) computes the CPI.
  • CSAI: Case-Shiller Adjusted Inflation substitutes actual home prices for OER in the CPI. I derive this measure starting with the CPI.

Inflation Matters

The Fed's focus on consumer inflation via PCE or CPI is seriously flawed.

The fact of the matter is "inflation matters" not just alleged consumer inflation.

Inflation matters because bubbles matter. My CSAI measure is certainly not perfect. But it is a better measure of inflation than anything that ignores home prices completely as do the CPI and PCE.

Case Shiller Home Price Index

Case-Shiller Home Price Index 2021-07

Supposedly there is no signs of inflation in the above chart. I don't buy it.

Yes, it's true that most people already have a home and only those looking to buy are directly impacted.

Housing used to be in the CPI directly but on the basis that housing is a "capital expense" not a consumer expense the BLS removed housing in favor of OER.

Until 2000 removal of housing from the CPI did not matter. The next chart shows the disconnect.

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Case Shiller National, Case Shiller 10 City, CPI, OER and PCE 

CS National, Top 10, CPI, PCE 2021-07

It's Inflation Stupid!

OK home prices are a capital expense. So what?

Inflation matters, not just alleged consumer inflation.

The idea that housing prices do not matter is absurd especially when the Fed has a stated mission to make up for the alleged lack of past inflation.

Fed Sponsors Bubbles

It's not possible to weight junk bond or equity bubbles but it certainly is possible to factor in home prices.

The Fed is actually sponsoring bubbles in a clearly overheated housing market.

For discussion, please see How the Fed Props Up an Overheated Housing Market in Three Pictures

For more details on a housing-adjusted CPI, please see Real Interest Rates Hit New Record Low as Home Prices Hit New Record High

Thanks for Tuning In

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