CPI Null Set (via The Economist)

This is a classic example of working the refs: If enough long-only fund managers/sell side pundits spew the same misleading nonsense long enough, it will eventually find resonance somewhere in the mainstream media.

Today’s case in point is from The Economist, a publication that ought to know better. They not only focus on the Core CPI, but they take it a step further: Core CPI ex Housing OER.

First off, I need someone to explain why food and energy is considered volatile — if the volatility has been exclusively in one direction. That’s not merely volatility, that’s a trend

Second, let’s credit The Economist with creating a whole new category of measuring increasing prices: Inflation ex inflation (ex inflation). That’s right, we take the basic measure of inflation, remove the vital components of life consumed by every living human being (food and energy). Then, just in case that is still too inflationary, remove Housing (see chart below). 

That’s Inflation ex inflation (ex inflation). 

We should take it a step even further. I propose a whole new category to measure inflation: CPI Null Set. Start with the basic CPI, then go to the Core, removing food  and energy. Then take out housing. Then remove everything else. Ta-da! No inflation!

Here’s an excerpt:

"But much of that jump is thanks to a sharp rise in the cost of housing (which makes up almost 40% of core CPI), particularly the category of “owners’ equivalent rent” which estimates the cost of living in a house by looking at rents charged on similar properties. Although this measure makes sense in theory (by living in your house you forgo rental income), it may now be overstating inflationary pressure.

As the housing market has slowed, fewer people are buying property, choosing to rent instead. That has pushed up rents. In turn, owners’ equivalent rent has risen too, even though homeowners have seen no change in the actual costs of owning their house. Because owners’ equivalent rent is estimated net of utility prices, recent falls in gas and electricity bills have paradoxically made matters worse.

Statistical quirks, in short, are distorting the picture. But what should central bankers do about it? Some suggest that owners’ equivalent rent should simply be dropped from the inflation index. That is what European statisticians have done. But credible central bankers cannot suddenly ignore an inflation component when it starts behaving in ways they do not like. That was the mistake made in the 1970s, when officials deluded themselves that inflation was under control by excluding ever more prices from their indices."

Funny, I do not recall The Ecomomist discussing how OER understated inflation over the past 5 years. Where were you guys? Oh, that’s right, no one was working the refs then. I guess quirks in reporting standards only matter if it impacts someone’s portfolios/bonuses.   

As poorly considered as that was, the Brits do manage to redeem themselves with a paragraph towards the end of column:

"The bigger point is that even if you take out housing costs the recent acceleration in core consumer prices does not disappear (see chart). And a variety of other gauges suggest that underlying inflation is on the high side and rising. The deflator for core personal-consumption expenditure (PCE), Fed officials’ favoured index, was up 2.1% in the year to April. The “trimmed-mean PCE deflator”, calculated by the Dallas Fed, which excludes those prices that have risen and fallen the most before taking a weighted average of the rest, is up 2.4%. The “median consumer-price index”, calculated by the Cleveland Fed, is up 3%. Look at these figures and the surprise is less that the central bankers are now so jumpy about inflation than that they sounded so sanguine earlier this year." (emphasis added)

Glad to see someone across the pond hasn’t drank the kool-aid.

Hey guys: You were on the verge of being punk’d. Get with it.


American inflation: Feeling the heat
Jun 22nd 2006 | WASHINGTON, DC
From The Economist print edition

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