What would the Fed do if economic factors were all it looked at?
Inflation measured by the "core" Consumer Price Index, which removes the volatile food and energy segments, jumped in August at the highest rate in 11 years, by 2.39%, a smidgen over the previous peaks in July 2018 (2.35 %), February 2016 (2.33%), and April 2012 (2.32%). Last time it rose at a faster rate was in September 2008 (2.47%):
The United States is currently undergoing the second oil-and-gas bust since mid-2014, or the same oil-and-gas bust , with two parts separated by a sucker rally. And then energy prices, which weigh 7.8% in the overall CPI, fell 4.4% from a year ago, with gasoline and diesel prices falling 7.0%.
These falls in energy prices reduced the overall CPI year-over-year increase from 1.81% in July to 1.75% in August, the Bureau of Labor Statistics reported this morning.
Inflation in Services
Consumers spend 70% of their money on services, which include everything from financial and health services (not medicine) to broadband and mobile phone services. That's biggie. In August, the CPI for services increased by 2.70% compared to a year ago.
"Inflation", expressed by CPI attempts to measure the loss of purchasing power for dollars, and not price increases due to higher quality products.
When your broadband speed goes from 2 Mbps to 50 Mbps in 10 years, but the price you pay remains the same (as was the case with our Comcast connection), you get 25 times higher quality of services for the same price – something which means you get more for your dollars, even if you pay the same.
Inflation measures the loss of purchasing power for dollars, not quality improvements. This is why quality improvements are removed from the index (via the infamous "hedonic quality adjustments"). At this conceptual level, "hedonic quality adjustments" make sense.
Price changes can be divided into two parts:
- The price of quality improvements,
- The loss of the dollar's purchasing power.
Your life becomes more expensive, driven by both factors, which together make up the overall increase in "your cost of living." And there is an endless debate about the hedonic quality adjustments that are being used targeted too aggressively.
Then a 2.7% increase in CPI for services measures the loss of purchasing power for dollars after removing the impact of improvements in mobile phone services, broadband services, data storage services and the like. The CPI services have been relatively stable since 2012:
The peculiar case of durable goods.
Durable goods are things like cars, washing machines, furniture, mobile phones and the like. Automation and other industry efficiencies along with globalization (transfer of production to cheap countries) have pushed down the cost of making goods.
The general rule in a non-inflationary environment is that durable goods that do not improve become cheaper over time as production and distribution become more efficient and costs are pushed down.
But under intense pressure from global competition, manufacturers are constantly trying to improve their products. These improvements allow them to charge more for their products, but since these improvements add value to the increased price you pay, they are removed from the inflation index (you know the drill, "hedonic quality adjustments"), so the durable CPI measures only the purchasing power of dollars in terms of durable goods, not the quality improvements.
So your cost of living increases because the car now has a 9-speed gearbox and better safety features, improved performance, more fancy dashboard electronics, front and rear cameras, automatic braking features and the like. However, when the cost of these quality improvements is removed, the car should have become cheaper due to the impact of production efficiency and globalization.
And this is kind of what happened. The chart below shows the CPI for durable goods – the actual index, not the percentage change of the index. Notice what may be the beginning of an uptick in recent months, after years of declines:
The trend of price declines in durable goods in previous years has been a theme in discussions by the Federal Reserve, also admits that these price falls may be the normal state of a competitive world with a constant drive to streamline production.
In terms of percentage change, the CPI for durable goods rose by 0.6% in August – the fastest increase since May 2012. The turnaround in the CPI for the trend for durable goods started towards the end of 2017, when prices fell less and less, until November 2018, when it was finally the first price increase since 2012:
So the inflationary forces continue to be active in services, as they have been. But now these inflationary forces are also starting to push up lasting commodity prices for the first time in recent years.
Durable goods and services constitute the bulk of "core" inflation measures, including the "core" PCE measure that the Fed uses as the benchmark for the self-selected inflation target of 2%. And after the appearance, its "low inflation" fright earlier this year, when the dollar failed to lose its purchasing power quickly enough, is about to reverse, removing another economic reason for further interest rate cuts.
Services are jumping. And # 1 Biggie jumps fastest. But everything contributes to GDP! Read … Financialization of the US Economy
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