One Thing You Need to Know About the Fed and Inflation

Federal Reserve - Interest Rates

Treasury_Inflation-Protected_SecuritiesYou may have noticed that the prices of things you buy seem to be getting a whole lot more expensive lately.  From food to gasoline to a whole host of other things people tend to rely on, the relentless push higher in the prices of things people need seems to know no end.  It’s borderline insulting that the Fed’s monetary policy is one that intentionally devalues each and every person’s economic reward (money) for the labor they provide to their employers and/or customers.

The policy of intentionally attempting to raise prices throughout society is so bad that employers are expected to provide people with cost of living increases.  These aren’t wage increases based on merit.  These are simply wage increases meant to help people keep up with rising prices.  In other words, there’s a silly little game being played in which Federal Reserve policy is meant to induce inflation, which forces employers to try to counterbalance that artificial inflation with wage increases.  The trouble for employees is that wages aren’t keeping up the way many expect them to.  And the result is a society that ironically becomes even more dependent on easy money policies—policies that tend to induce even more inflation, causing even more people to fall behind.

In addition to the policy of intentionally creating inflation, what’s also insulting is that the Fed, when deciding the appropriate path for monetary policy, doesn’t favor the Consumer Price Index (CPI) as many might expect.  Instead, the Fed favors Personal Consumption Expenditures (PCE), which measures goods and services purchased by households and nonprofit institutions serving households.  In other words, the Fed is more interested in the cost of what you are actually buying, rather than the cost of what you would be buying had there been no inflation in the first place.  In a nutshell, if you switch from eating steak to eating chicken, despite the fact that you would rather be eating steak and were forced to switch because of much higher prices, the Fed wouldn’t care.  This is because the Fed cares about the price of the stuff you buy—and now you’re buying chicken.  Now, imagine a future in which you have to continue trading down as prices march higher, but the Fed keeps noting that PCE is trending at or below the level preferred by the Fed.

In a July 2013 message from James Bullard, President and CEO of the Federal Reserve Bank of St. Louis, there is an interesting chart included at the end.  I’ve included the chart below:

CPI versus PCE

Notice how headline CPI has been trending well above headline PCE, but that headline PCE seems to be tracking the Fed’s 2% inflation target quite well.  When viewing this chart for the first time, I imagine it’s hard for many readers not to have the word, “goal seek” pop into your mind.

To conclude, many people have a hard enough time trusting the accuracy of the CPI.  In a world in which the monetary authorities use PCE as the preferred inflation gauge, I would imagine many more will struggle to rectify the differences between their personal inflation experiences and those the Fed tells us society is experiencing.

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