Joseph G. Carson

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Policymakers are involved in another debate about inflation, but this time its because some think reported inflation is too low, not too high. The new view is not based on any formal review or research. Rather, some policymakers think a consistent failure to hit the 2% price target risks "unanchoring" inflation expectations, resulting in a much lower ceiling on official interest rates than otherwise would be the case, thereby limiting policymakers ability to respond to a weakening economy. As a result, some policymakers have floated the idea that an intentional over-shoot of inflation, or a so-called makeup policy should follow any under-shoot.

One would think a good starting point for this debate would start on price measurement, what’s included and what’s not, as there is no absolute perfection or agreement on how to measure the change in prices. It was not too long ago (mid-1990s) policymakers led by then Fed Chairman Alan Greenspan complained that published price statistics over-stated inflation. That comment started a political outcry for change, the naming of an Congressional Advisory Commission and the issuance of the “Boskin” report---which proposed a number of changes in price measurement, all with the intent to lower the published rate of inflation.

The statistical agencies ended up introducing a number of changes including product substitution, quality adjustments and faster introduction of new goods. There is no consensus on how much these changes reduced the rate of consumer price inflation. Estimates range from a few tenths to as much as two percentages points, and it is unclear if these reductions in the rate of inflation are a permanent feature each and every year, or fluctuate from year to year.

Roughly the same time government statisticians were implementing recommended changes from the "Boskin report" they also decided to abandon the rent series for homeowners and to use the renters rent series for homeowners and the rental market. Research conducted by two Federal Reserve staff economists found this change had the effect of keeping “measured inflation artificially low” during economic expansions. In other words, the findings of the Fed staff concluded that the natural lift to reported inflation from a rise in housing activity during business upswings has been neutralized if not reversed by this change in measurement.

Ordinarily, changes like this would not matter but the combined rent series account for 30% of the overall index. And estimates from the new measurement of housing costs, depending on the status of housing market, range from as a little as a few tenths to as high as two percentage points---or fairly close to the estimates of the proposed changes in the “Boskin” report.

Biases in consumer price measurement of a few tenths of the annual rate of inflation do not matter much when reported inflation is high. Yet, these biases do matter when, as is the case today, reported inflation is low, and policymakers remain puzzled over why cyclical inflation has not been consistently higher.

Controversy over the consumer price index is not new. Back in 1997, then Fed Chairman testified before Congress stating that the aim of any measure of inflation is that it needs to be unbiased. Mr. Greenspan argued "an examination of all available evidence" should be conducted to determine if the current measurement of prices had an equal chance to overstate and understate reported inflation. Mr. Greenspan's concluded based on the evidence at that time there was a 100% probability that inflation was being over-stated. Similarly, one could conclude that based on the research of the Fed's staff on the measurement of housing costs there is a 100% probability that reported consumer price inflation is being understated, and has been for some time.

As policymakers undertake a review of their policy framework it would be prudent to also examine it's key focus, the measurement of consumer prices. The real danger in this debate is that policymakers make a change in policy to address a problem that doesn't actually exist.


Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
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Policymakers are involved in another debate about inflation, but this time its because some think reported inflation is too low, not too high. The new view is not based on any formal review or research. Rather, some policymakers think [...]

The New Inflation Debate

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At the January 29-30 Federal Open Market Committee meeting policymakers decided to adopt a “patient posture” arguing that they saw “few risks” in maintaining the current target range for the federal funds. Easy money conditions have created large financial balances that already have the potential to destabilize the business cycle. As such, policymakers face an uneasy trade-off between one economic objective (price stability) and another (financial stability). In hindsight, the decision to risk financial stability may be viewed as a mistake.

Policymakers look at asset prices only insofar as these price movements influence the general inflation trend. That is myopic and misguided on several fronts.

Real estate prices for owner-occupied housing and their cousin “implied rents” were part of previously published consumer price series only to be removed (in 1983 and 1998) when government statisticians argued “bad data samples” biased the accuracy of the measurement. Removing the price signals from the housing market for technical statistical reasons does not mean that real estate inflation is no longer part of the general inflation trend in the economy or suddenly unimportant to monetary policy.

Equity prices, meanwhile, can convey important information about the supply of liquidity, risk-taking and speculation, important factors for policymakers to consider when deliberating on the overall stance of monetary policy.

Asset prices run through the economy and financial markets, creating large gains (and losses during reversals) in nominal wealth to holders of real and financial assets. All of the nominal wealth gains generated during the tech-equity and housing bubbles were lost during the subsequent corrections. In 2018, household financial balances in relation to nominal income hit a new record level, exceeding the peak valuations recorded at the end of the tech and housing bubbles.

The import of large financial balances is not lost on policymakers. At the Federal Reserve Bank of Kansas City symposium at Jackson Hole in August 2018, Federal Reserve Chairman Jerome Powell stated, “in the run-up to the past two recessions, destabilizing excesses appeared mainly in financial markets rather than in inflation.”

Tipping points for asset price cycles can come from a variety of sources or factors. For example, at some point profit rates may fall and not live up to the expectations expressed in equity prices or household may have taken on too much debt and credit markets begin to turn away from extending new loans, or it could come from just a normal tightening of financial conditions.

It is worth noting that as financial balances have gotten larger and larger in relation to income the tipping points have occurred at successively lower and lower levels of interest rates. Official policy rates peaked at 6.5% during the tech-bubble and 5.25% at the peak of the housing bubble. Although it is too early to call a peak in the current cycle there was an alarming “wobbliness” in equity prices in the fourth quarter of 2018 (with prices shrinking nearly 20%) when official rates were only a bit above the 2% mark and perceived to go even higher.

The lower and lower rate threshold suggests the fundamental underpinning for each asset cycle has become weaker and weaker. The fact that equity asset prices were pressured at such a low level of nominal rates is a surprise, but maybe this is one of the unintended consequences of flooding the markets will excess liquidity, via record low rates and asset purchases, for the past decade. At some point, even small reversals in liquidity provisions trigger an out-sized (negative) impact on asset prices.

Downturns can develop from the asset markets themselves, and they can develop quite quickly as evident in the large 1.2% decline in retail sales for December against a backdrop of relatively strong gains in employment and wages.

It is hard to predict what happens next, as easy money "buys" the policymakers time. Yet, the real danger in promising easy money conditions is that it fuels more speculation and risk taking in the asset markets which ultimately threatens the business cycle policymakers are trying to protect. The key question is whether or not this asset price-led business cycle will have a different outcome than the previous two? I have few doubts.


Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
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At the January 29-30 Federal Open Market Committee meeting policymakers decided to adopt a “patient posture” arguing that they saw “few risks” in maintaining the current target range for the federal funds. Easy money conditions have [...]

The Fed's Mistake

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It has long been observed that inflation is a monetary phenomenon. The foundation for this observation was developed decades ago when accelerating and decelerating rates of consumer price inflation were associated with similar patterns of growth in money. Nowadays, the concept of money itself is under constant refinement, and money growth is no longer part of the Federal Reserve objectives, which raises an important question, is there a new working theory of inflation?

I raise this question for the simple reason that structural changes in the financial markets coupled with regime changes in the conduct of monetary policy have altered the transmission process of monetary policy in a way that inflation is no longer predictable based solely on money growth nor limited to the standard price measures.

In the past several decades, the US has experienced two fundamentally different types of inflation (or price) cycles, with one associated with fast growth in money while the other form was not, and yet each cycle proved to be a monetary-driven event with similar outcomes.

For example, from the early 1960s to the early 1980s the US economy experienced successive periods of relatively fast gains in consumer prices and all were associated (fueled) with fast gains in money. And, from the mid-1990s to today, the US economy has experienced consecutive cycles of unprecedented gains in asset inflation, fueled by relatively low interest rates, easy credit conditions assisted in part by growth of non-bank banks, and more recently with additional monetary accommodation via the expansion of the Fed’s balance sheet.

Although of a different form, the inflation (or price) cycles had a number of common characteristics. For example, all cycles proved to be persistent as each one had a self sustaining feature as the more and more prices rose it led to the expectations of more price gains, creating an inflationary (or speculation) mindset that was hard to break in the real economy or in the minds of investors. Also, inflation cycles created market distortions, such as allocating too much capital towards inflation-benefitting industries (i.e. commodities) or conversely sending too much capital towards asset-price benefiting industries (finance and housing). Yet the important common feature was that all inflation cycles ended with a bad outcome (recession); although the jury is still out on the current asset-price cycle.

Policymakers confront traditional inflation cycles because inflation feeds in part on itself, creating uncertainty and distortions in the economy and the flow of capital, depriving the economy of reaching its potential and eventually forcing a substantial tightening of financial conditions and a recession to unwind the destabilizing forces. Yet, asset inflation cycles also feeds in part on itself, triggering unbalanced capital flows, wealth inequality, ultimately leading to costly real and financial imbalances that eventually unravel driving the economy into recession.

If both forms of inflation cycles have like outcomes shouldn’t monetary policy view them similarly as they relate to the Fed’s mandates of financial stability, maximum employment and price stability?

Many questions remain unanswered, but perhaps the most important question has already been answered in that asset price inflation has become a new permanent feature of the transmission of monetary policy. Part of this is due to regime shifts in the conduct of monetary policy as policymakers moved from targeting money to targeting real interest rates (consumer prices less official rates) and now directly targeting consumer price indices. Real and financial asset prices are not part of the published prices so their price cycles have been able to run free of monetary oversight. Also, the new policy tool, the expansion of the Fed’s balance sheet, is intended to work through the portfolio channel, directly lifting the price of a broad range of assets.

The new working theory of inflation is that it is still a monetary phenomenon but today’s inflation form is shaped by how monetary policy is implemented. The new targeting regimes has let the real cost of credit for real estate and equity purchases to remain too low for too long, driving fast asset price cycles. Admittedly, asset prices are determined by many factors other than monetary policy, but recent perceived shifts in monetary liquidity (first tighter and then looser) followed by abrupt declines and sharp reversals in equity prices illustrate how closely linked the asset price cycle is to expected shifts in the stance of monetary policy. Policymakers should not ignore these price signals as past asset price cycles have led to bad outcomes.


Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
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It has long been observed that inflation is a monetary phenomenon. The foundation for this observation was developed decades ago when accelerating and decelerating rates of consumer price inflation were associated with similar [...]

A New Working Theory of Inflation

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Paul L. Kasriel

Private credit involves nonbank financial institutions direct lending to private firms. It is a rapidly growing sector of the financial markets. According to McKinsey & Company, private credit “totaled nearly $2 trillion by the end of 2023, roughly ten times than it did in 2009”. Private credit increased in popularity following the Great Financial Crisis after which commercial banks came under increased regulation. But US commercial banks have steadily become involved in the private credit market indirectly. Banks have done this by increasing their lending to nonbank financial institutions, the institutions that make the direct loans to businesses.

Chart 1 shows the steady growth in commercial bank lending to nonbank financial institutions starting in 2015 (when the series first became available form the Federal Reserve). In January 2015, commercial bank loans to nonbank financial institutions were 4.2% of commercial banks’ total loans and leases. By February 2025, this percentage had risen to 9.4%.

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Historically, a rapidly growing financial asset category, such as private credit, runs into a correction.  One sector of the economy that could be the catalyst for a correction in the private credit market is household spending. Delinquencies are rising in the areas of auto-loan and credit card debt, as shown in Chart 2. These delinquencies are likely to lead to more restrictive terms for new credit in these sectors. Moreover, current household borrowers may cut back on their general spending in order to service their outstanding debt. If the tariffs threatened by the Trump administration come to pass, the higher cost of consumer goods and the downstream job layoffs that would likely occur also would adversely affect household spending.

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The capital positions of US commercial banks are much improved compared to what they were just before the bursting of the housing/mortgage bubble in 2007. So, a bursting of the private-bubble would not have nearly the negative effect on the solvency of commercial banks as the bursting of the home-mortgage market did. But, given the US commercial banking system’s rising exposure to the private-credit market, problems in the private-credit market would have a negative impact on commercial banks, which would cause them to restrict their lending.

Commercial Banks Increased Exposure to the Private Credit Market

Charles Steindel

State labor markets were generally little-changed from December to January, but were arguably a bit on the soft side. Four states (Georgia, Indiana, Missouri, and West Virginia) had statistically significant declines in payrolls; moves in all others were not significant., though in some cases were up or down by more than 10,000 (very remarkably, California’s job count was reported at 18,032,400 in both December and January).

Pennsylvania was the only state to report a statistically significant change (up .1 percentage point) in its unemployment rate. The highest unemployment rates were in Nevada (5.8%), California (5.4%), DC (5.3%), Kentucky (5.3%) and Michigan (5.3%)—due to the annual revisions, in some cases the rates look substantially different than the initially reported ones for December (Michigan, for instance, its December rate changed from 5.0% to 5.2%, while the December rate in Illinois moved from 5.2% to 4.9%). Montana, Nebraska, New Hampshire, North Dakota, South Dakota, and Vermont had unemployment rates under 3.0%, while South Dakota’s 1.9% was the lowest in the nation.

Puerto Rico’s unemployment rate was unchanged at 5.4%--unusually, lower than the state rate--while the island’s job count moved up by 2,800.

State Labor Markets in January 2025

Trump's trade war is essentially a conflict between his economic team and American businesses. This is because the Trump economic team, along with the president, holds an out-dated perspective on international trade. The "old" way of analyzing foreign trade with an export being a "win" and an import representing a "loss" for an economy is too simplistic nowadays since companies operate without national borders and many times are on both sides of the transaction. Compelling U.S. multinationals to relocate their operations domestically would cause major disruption, higher prices, considerable losses, financial market turmoil, and ultimately make U.S. companies less competitive globally.

The Bureau of Economic Analysis (BEA) constructs an ownership-based trade account, which incorporates the role multinational companies play in international trade. This framework adds the direct investment income and receipts that are associated with international transactions. The ownership-based trade account reduces the traditional trade measure by "Half". Is the Trump economic team even aware of the existence of this statistical measure of international trade? In politics, one can create a misleading narrative, but when developing economic policy, it's crucial to base decisions on "facts."

The ownership-based trade measure offers a more accurate modern-day account of international trade, largely due to the substantial overseas investments by US companies over several decades. For example, US majority-owned foreign affiliates have $3.4 trillion in physical assets like property, plants, and equipment, with 50% of these investments in Europe and another 16% in Canada and Mexico. These assets have helped generate $6 trillion in gross sales and $300 billion in net income, according to the most recent data from 2022.

US trade agreements have been crucial in encouraging American companies to grow internationally. Currently, the US has trade agreements with 20 countries, the most significant being the North American Free Trade Agreement with Canada and Mexico. Despite these agreements, the Trump administration intends to impose tariffs of up to 25% on a wide array of manufactured goods, even in cases where trade agreements are in place, to incentivize companies to manufacture products within the US.

The reasoning behind Trump's tariff strategy is suspect. First, it implicitly recognizes a significant cost gap between domestic and international production that isn't solely to do unfair trade practices. Second, it does not acknowledge that higher product prices are inevitable, as producing goods in the US would be unprofitable without tariffs. Third, it overlooks the costs involved in creating a new manufacturing "ecosystem," including who will bear these costs and the time required to establish it. Fourth, it places US companies with global manufacturing operations in a situation where they may need to sell or cease some activities. Lastly, it overlooks the fact that simply having a trade surplus does not ensure a strong economy (as shown by Japan and Germany), nor does it necessarily lead to a better standard of living.

The Trump tariff approach is 30 years behind the times. It may have yielded certain economic and financial benefits when exports and imports were associated with specific country names, but that world no longer exists.

Nowadays, the economy, workers, and companies would benefit more if the Trump administration collaborated with US businesses to create a forward-looking manufacturing plan and invested in educating the youth or future workforce. Regrettably, the administration intends to prolong the 2017 tax legislation, which advantages high-income earners, prioritizes consumption over investment, leads to massive budget deficits, and simultaneously dismantles the education department.

"Has the Era of American Exceptionalism Ended?" If Trump's tariff strategy is fully implemented, it raises the probability that it has.

The US Trade War: Trump's Economic Team Clashes With US Corporations

Viewpoints: February 2019

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The New Inflation Debate

The Fed's Mistake

A New Working Theory of Inflation