Washington, DC —(ENEWSPF)—June 26, 2018
Contact: Karen Conner
Using the wrong measure of inflation could result in the Federal Reserve Board (Fed) raising interest rates prematurely, needlessly keeping people out of work and undermining the intention of its 2.0 percent average inflation target. That warning, as well as a solution, is contained in the Center for Economic and Policy Research’s (CEPR) new report, Measuring the Inflation Rate: Is Housing Different?
The Fed has tended to look at core Consumer Price Index (CPI) and Personal Consumption Expenditure Deflator (PCE), which pulls out volatile food and energy prices, as the key measure of the underlying rate of inflation. This report, by senior economist Dean Baker, argues that the Fed should also remove the shelter component from the core inflation indexes for a more accurate gauge of the underlying inflation rate. The inflation rate in shelter prices is growing much faster than the core indices, and factors related to the overall economy does not drive these rising shelter costs.
In prior years, shelter component prices were not such an outlier, as they generally moved roughly in step with the rest of the core index. This is no longer true. Inflation in the shelter component averaged 1.7 percentage points over the core inflation rate in the PCE data between January of 2015 and April of 2018. In the CPI, the gap has averaged 1.6 percentage points over this period. In the CPI, the gap has grown to 2.2 percentage points over the last year.
Like taking aspirin for swelling, the Fed medicates swelling inflation by incrementally raising interest rates, making borrowing more expensive. But when the core inflation rate is driven by higher housing costs in a handful of metropolitan cities, not only does the medicine not work, it can intensify the inflation.
One of the drivers of rising housing costs is lack of supply. If the Fed continues to raise rates, it becomes more costly to develop housing, and that will likely result in diminishing the supply of new housing, further constraining the housing market and resulting in higher housing prices.
Using higher interest rates to contain inflation when the non-housing core inflation rate in the is still well below the Fed’s 2.0 percent target, means that we may start the next recession with an inflation rate far below 2.0 percent in most sectors. With inflation expected to fall in response to a downturn, the Fed is likely to have little room to boost the economy using conventional monetary policy if it hits the zero lower bound for the Federal Funds rate at a time when the inflation rate in most sectors is near zero.
The Center for Economic and Policy Research (CEPR) is an independent, nonpartisan think tank that was established to promote democratic debate on the most important economic and social issues that affect people’s lives. CEPR was co-founded by economists Dean Baker and Mark Weisbrot in 1999. CEPR’s Advisory Board includes Nobel Laureate economists Robert Solow and Joseph Stiglitz; Janet Gornick, Professor at the CUNY Graduate Center and Director of the Luxembourg Income Study; and Richard Freeman, Professor of Economics at Harvard University.
Source: www.cepr.net
