Why US inflation doesn’t matter: 3 things a Treasury statistician should know | Michael Hiltzik

1. Inflation is not a crisis The reason that inflation has been consistently lower than advertised in the US’s official consumer price index (CPI) and the inflation-adjusted measures used by the Federal Reserve is…

Why US inflation doesn't matter: 3 things a Treasury statistician should know | Michael Hiltzik


1. Inflation is not a crisis

The reason that inflation has been consistently lower than advertised in the US’s official consumer price index (CPI) and the inflation-adjusted measures used by the Federal Reserve is because “inflation” is simply an accounting term. Contrary to the widely accepted idea that actual inflation does not matter, serious economic analysis shows that the government’s National Income and Product Accounts underestimate it.

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“Inflation” itself is a crucial accounting term. If the IRS wanted to encourage households to spend, they would write the rules so that assets are worth what they are, regardless of how they are spent. Instead, the IRS ensures that individuals’ savings with defined-benefit pension plans are considered the value of the account assets. As a result, households and companies can plan their cash flows accordingly and make informed decisions about consumption.

In other words, while the CPI asks households to estimate future spending, the same isn’t true of its assets. Instead, households have no idea how to best measure their assets. Due to this deficiency, official inflation figures have been consistently lower than desired, at least for a decade now. The consequence is that consumers feel more “inflation”, even when they may not actually be experiencing it, creating inflation psychology.

But the average consumer can’t understand the nuances of financial accounting standards – for instance, how the value of house payments is determined. And real people don’t control the levers of economic policy so that they can get their hands on the official statistics. In response, the US government started issuing provisional numbers that are the best that it can produce. What this means is that in many cases, the official US data now underestimate inflation, which leads to “inflation hysteria” and allows leaders to deliver bad economic policies because they know that they will only be surpassed in the statistics.

2. Personal and business consumption expenditures have been strong

Real income growth has remained sluggish over the past decade. Without a boost in real income growth, consumers could never fulfill their saving goals. In contrast, since 2001, real personal consumption expenditures as a percentage of GDP have gone from 65.5% to 70.1%, meaning that the government is not accurately tracking what households actually consume.

The revenue side of the US’s fiscal balance is still under-reported. On top of that, understated government spending and understated business investment have also added to the distorted picture. One thing is certain: consumer spending has been high, and it is set to remain high, which is why it cannot be lowered while real incomes remain flat.

The good news is that certain misgivings do exist about the economy – they are called inflationary expectations. If households and companies fear higher prices for goods and services, they would probably reduce their spending unless wage hikes lower their real income. This is not happening at the moment, though it should. As one sign, the cost of borrowing against asset growth has been declining in the United States for the past year, while demand for debt instruments has been increasing. As future demand for that debt grows, the fear of higher prices and falling real incomes can be lowered.

The increase in real wages since 2014 may partly explain why real personal consumption expenditures are likely to increase this year. Moreover, gross productivity is set to accelerate from 2.1% annualized in the first half of 2017 to 3.3% in the first half of 2018. As the boom in the office rents demonstrates, there is room for future productivity growth, which should hopefully translate into higher wages.

3. The US economy is not overheating

Another myth is that US unemployment is too high. The US jobless rate has only risen slightly since Obama was elected and average hourly wages have not grown faster than growth in productivity in the last 12 months. Although the health and well-being of the US economy is not the same as that of other countries, many members of the current administration’s cabinet have a history of promoting unwarranted policies to stimulate the economy.

At the same time, critics have not yet explained why consumer spending is not coming back after the Great Recession. As more normalization occurs and the bulk of the unemployed return to the workforce, expectations for higher consumer spending should improve, as the government’s models would have us believe.

The truth is that the US economy is not overheating. It is reaching a point where it’s appropriate to encourage spending, rather than worries about higher prices.

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