Study: Inflation Is Much Worse Than The Government Claims – The Federalist

Even though inflation has reached 40-year highs, topping out at 8.6 percent for the month of May, some took minor solace in the fact that prices havent increased at the rates seen during the Jimmy Carter era. But one influential analyst thinks that solving skyrocketing prices will require nearly as much effortand quite possibly, economic painas breaking the back of inflation did during the 1970s and early 1980s.

Former Treasury Secretary and longtime Democrat Larry Summers recently co-authored an important paper analyzing long-term inflation trends and statistics. The paper demonstrates that changes to the way the federal government measures inflation via the Consumer Price Index since the Carter era understate the current scope of the problemand the challenge the Federal Reserve faces in getting inflation under control today.

Two changes to the inflation measureone a one-time methodological change, and the other a long-running trendexplain much of the apparent difference in CPI rates between the late 1970s and today. The first comes from a 1983 move by the Bureau of Labor Statistics to remove homeownership costs from the CPI measurement and replace them with a metric called owners equivalent rent.

The new metric quantifies what homeowners would receive for their homes on the rental market. As one might expect, the metric closely tracks the rental market. (Rent is a separate component of the CPI.) Most importantly, shifting from homeownership costs to owners equivalent rent to calculate homeownership costs eliminated the direct effect of mortgage ratesand therefore interest rate policyon calculating the rate of inflation.

Prior to the 1983 methodological change, the very direct link between interest rates and the homeownership component of the CPI magnified the effects of efforts to combat inflation. Consider the two possible scenarios:

Summers and his co-authors argue that the interest rate CPI ratchet (my words, not theirs) of scenario one helped lead to the double-digit inflation rates of the late 1970s and early 1980s. While the 1983 change to the methodology means we will no longer see this ratchet in the monthly inflation statisticswhich explains why inflation hasnt risen above 10 percentit also means we wont benefit from the benefits of scenario two (i.e., a downward ratchet) once inflation starts to get under control.

Summers and company also note that, compared to past decades, a smaller portion of the Consumer Price Index consists of goods with volatile prices. This suggests that combating inflation will require a longer and more sustained effort.

For instance, in the early 1950s, food and clothing comprised roughly half of the total Consumer Price Index, as opposed to approximately 17 percent today. The shift means that more elements of the CPI come from sticky industries and sectorsones less amenable to sudden price shifts.

While a grocery store or clothing retailer changes its prices quite often, for instance, manufacturers of computers or other durable goods alter their prices less frequently. The fact that the latter types of sectors dominate the CPI compared to prior decades suggests that wringing inflation out of the economy will not happen overnight, nor very easily.

Summers famously predicted last February that inflation would accelerate if Democrats rammed through their $1.9 trillion stimulus legislation. Sure enough, it did. His newest analysis therefore bears watching, as does one ominous conclusion: that bringing inflation down to the Feds desired 2 percent level willrequire nearly the same amount of disinflation as achieved under [Federal Reserve] Chairman [Paul] Volcker.

Volcker, who served from 1979 to 1987, eventually tamed inflationbut not before having to raise interest rates as high as 20 percent, sparking the deep recession of the early 1980s. American families could face a reprise of these hardships in the coming months and years, thanks in no small part to the profligacy of both the Federal Reserve and spendthrift lawmakers over the last 70 years.

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Study: Inflation Is Much Worse Than The Government Claims - The Federalist