Inflation is Over

I’m not quite sure why “Team Transitory” has lost its voice. Jerome Powell went to quite a bit of work to clarify (pdf) the biases of the CPI index. Much of the shelter component tracks the imputed rents of owned homes, which really have only the most tentative relevance to short term monetary trends, since no cash payments are involved. Even rent inflation for rented units is reported in the CPI with a lag because it is based on survey data of rent changes over a period of several months. Some Fed researchers have even been working on an alternative measure to counter this.

I think we can get most of the way to a more useful CPI measure simply by removing the shelter component. At my old blog, and in some of my other writing, I have noted how rent inflation has pushed the Fed into undershooting their target in general and into triggering temporarily disruptive deflation.

Core CPI inflation excluding shelter has routinely been below 2%. Yet with this now, 25 year long pattern, where rent inflation (which is most of the shelter component) outpaces general inflation aggressively, year after year, so many well-meaning experts, policymakers, etc. think that our reaction to high housing costs should be tight monetary policy. It’s a sentiment I think we just have to accept can’t be fully corrected. (Here’s a 2 hour Frontline episode that aired last night, which, in reference to this period, was titled “The Age of Easy Money”. Here’s a photo taken of my house while I was watching it. I’ve been resting and eating chocolate today.)

Here is a chart of CPI measures for all consumer prices (blue), core CPI (black), and all prices except for shelter (red). Non-shelter prices peaked last June. Let me make this clear. I’m not saying that the rate of non-shelter inflation peaked last June. I’m saying non-shelter prices have had 8 months of cumulative deflation. We are now 8 months into the end of transitory inflation. We did it. It was transitory. Now we can move on.

I can’t understand why there isn’t more pushback on using trailing 12 month inflation measures, when trend shifts are what everyone is worried about, and all the non-shelter inflation happened in the first 4 months of that measure.

Here is a measure of annualized trailing 6 month core non-shelter CPI (CPI excluding Shelter, Food, and Energy). This helps to capture the trend shift more quickly without adding a lot of month-to-month noise. 2% has basically been a cap for 20 years. Then, in mid-2021, it busted above that cap. Then, in mid-2022, it went back down to 2%. The red line above, which includes food and energy, has been pushed down a bit by reversal of some of the inflation in those categories. Core CPI inflation without shelter, food, or energy, which is the blue line below, has settled pretty thoroughly back at a 2% rate. If there aren’t any big changes in the next few months, this measure should just start moseying down the same line it has been on for months now, and for years before 2021.

Here is a cumulative look at these measures. Shelter CPI (red), Core CPI (black), and Core CPI excluding Shelter (blue). I think this really drives home the point about how much the housing supply problem has been tricking us into too-tight monetary policy. Core CPI (except for the brief Covid bump), just moves along within a few points of the 2% path, and basically the inflation rate of things that monetary policy can cyclically control has to move below trend to counteract the housing supply problem that just keeps moving rent inflation above trend.

There is no functional point in trying to pull that black line back down to the neutral trend! Until we solve the supply problem, we will have the additional problem that there will be a large number of voters, policymakers, academics, and practitioners, who will mistakenly and passionately believe that it is our prudent duty to make ourselves poor enough to match with our crappy housing supply.

So many things will be easier when we fix the housing supply problem. In the meantime, break out the champagne, because we defeated transitory inflation, and so all the Fed’s job now should be easier than we feared it could be. There is still a lot of pent up demand because of Covid-related supply chain issues, and now we can let that demand roll with less concern, because inflation was only transitory after all.

One way this is key: If, say, housing starts begin to accelerate, that is good news, not bad news!!! That doesn’t mean we are “heating up” again. It means that the pesky supply chain problems that were responsible for transitory inflation are abating. Accept the win! Celebrate the win!