Viewpoints: 2023

The July 12, 2023, WSJ article, " Measure It Differently, And Inflation Is Behind Us," triggered a lively debate on housing costs in the CPI. The WSJ article argues that "no one pays" the rent used to measure owners' housing costs, so it should be overlooked or ignored. No one liked the results when BLS included "actual" housing costs based on prices, so government statisticians, academics, and politicians collaborated to change it.

So what is best, a CPI with no price for housing costs, a "fake" price, or an "actual" price? The answer is more than academic, as it will have significant implications for monetary policy and how the business cycle runs and ends.

The main opposition to including the price of a house in the CPI stems from the view that housing is an investment item, disqualifying it from inclusion in the consumer price index. Yet, the CPI has other investment items (e.g., watches, jewelry, etc.). But since the weight of those items is small, their inclusion is not controversial. So is the housing issue, the investment angle, or the weight in the index? It appears to be the latter, as "consistency" in measurement takes a back seat.

Critics also argue that people borrow money to purchase a house. So if the cost of a home, including financing costs, increases every time the Fed raises rates, housing inflation would rise, forcing the Fed to raise rates again and again. People borrow money and finance (credit cards, auto loans, etc. ) every good and service in the CPI, and these financing charges have significantly increased since the Fed raised the official rate. So why should housing financing be treated differently?

A consumer price index, including house prices, does not necessarily mean a higher consumer price index. The consumer price index will yield the same result if house price increases match other items' average growth. Only if house price increases were significant and persistent would there be an impact on the CPI.

The CPI, the government now publishes, has increasingly been enmeshed in the politics of the numbers. Printing a lower CPI than a higher one is more politically acceptable, even if that means including "fake" or "inaccurate" prices over actual prices.

With house prices living outside the standard price index nowadays, it is impossible to ascertain the aggregate actual inflation rate in the economy. That makes the Fed's job on price stability more complicated. That's because setting rates for a price index without housing risks the real cost of credit too low for real estate. Fifty years ago, Professors Alchian and Klein authored a paper, "On a Correct Measure of Inflation, stating " a price index used to measure inflation must include asset prices." Their analysis and conclusion are still valid today.

For a third straight month, the initial estimate of state labor markets for June had only 5 states sieeing statistically significant increases in payrolls, none appreciably numerically large. New York had the highest absolute gain (28,100) and Alabama had a .9% gain. Two states had statistically significant declines, with Indiana losing 13,900 jobs and Vermont recording a 1.4 percent drop (the other 5 New England states had insignificant declines).

11 states had statistically significant drops in unemployment from May to June (the same number as in May). Maryland’s .4 percentage point decline was the highest. Yet again, Nevada’s unemployment rate stayed the highest in the nation at an unchanged 5.4 percent. In another repeat from May, no other state had a rate more than a point higher than the national 3.7 percent, though DC’s was 5.1 percent. Alabama, Maine, Maryland, Montana, Nebraska, New Hampshire, North Dakota, South Dakota, Utah, Vermont, and Wisconsin all have rates more than a point lower than the nation, with New Hampshire and South Dakota both at 1.8 percent. California, Texas, Illinois, Washington, and Delaware (along with DC) are the states other than Nevada with rates at or above 4 percent.

Puerto Rico’s unemployment rate stayed at 6.1 percent. The job count on the island moved below 950,000. The bulk of the 8,200 drop was in the public sector.

The economy remains resilient and core measures of inflation are stubbornly high in the face of the most aggressive Fed tightening in decades. This resilience is partly a result of government stimulus programs during the COVID-19 pandemic. These programs generated a stockpile of excess savings that has continued to support household spending through rising inflation and higher interest rates. The Fed needs to counter that fiscal expansion in its fight against inflation.

Despite all the layoffs and furloughs, household income jumped during the pandemic due to the massive fiscal stimulus. Chart 1 shows the actual level of disposable personal income through the pandemic compared to trend. The income supports totaled more than $2 trillion in 2020-21. As the chart shows, the rise in income supports matched disposable personal income almost dollar for dollar.

State real GDP growth in 2023:1 ranged from North Dakota’s 12.4 percent annual rate to 0.1 percent in Rhode Island and Alabama. Growth was generally strongest in agricultural regions (though estimating the growth of farm output in the first quarter is always problematic). Northeastern states grew more slowly, in some instances in part due to weakness in agriculture, in others losses in manufacturing.

State personal income growth rates ranged from Maine’s 11.4 percent to Indiana’s -1.0 percent. As always, erratic swings in transfer payments account for much of the variation by state. Net earnings (employee compensation plus proprietors’ income) growth was strong in agricultural states, presumably due to a rise in farm income associated with the increase in agricultural output.

There is an economist in Chicago who has been known to see a silver lining behind every cloud. For example, after some natural disaster that resulted in hundreds of millions of dollars of damage to structures, this economist had been known to say that on the bright side, think of the rebuilding activity that will take place. By this logic, if the federal government wanted to increase the pace of economic activity, it could call on the US Air Force to carpet bomb some selected suburb, giving the residents plenty of notice to vacate the their premises with their irreplaceable possessions. (You might want to Google Bastiat’s “broken window fallacy” for the nonsense of this). I bring this up because after the debt-ceiling increase/extension legislation was signed into law on June 3, 2023, analysts, who unlike the aforementioned Chicago economist, see a cloud behind every silver lining. Even before the debt-ceiling bill hit the desk of President Biden, these nattering nabobs of negativity (you youngsters can Google this phrase) were saying that the rebuilding of Treasury balances at the Fed would suck liquidity out of the financial system, which, in turn, would cause all sorts of unspecified problems in the financial markets.

All else the same, it is true that an increase in Treasury deposits at the Fed would drain reserves from the banking system. But all else has not been the same in this case. Let’s go to Chart 1. Plotted in Chart 1 are the four-week billions of dollars changes in reserve balances held at the Fed by depository institutions (the blue bars), Treasury deposits at the Fed (the red line) and reverse repurchase agreements (RRPs) with the Fed (the green line). The last data points plotted are for the week ended June 28, 2023. In the four weeks ended June 28, Treasury deposits at the Fed increased by $360 billion, which, all else the same, would have drained that amount of reserves from the banking system. Yet, in the four weeks ended June 28, reserves at the Fed contracted by only $29 billion (the last blue bar plotted). Evidently, all else was not the same. One major factor that was not the same was the amount of RRPs executed with the Fed. An increase in RRPs drains reserves from the banking system; a decrease in RRPs adds reserves. In the four weeks ended June 28, RRPs executed with the Fed declined by $344 billion, which offset all but $16 billion of the reserves drained via the increase in Treasury balances at the Fed.

The construction of the leading indicators has many flaws, but one of the more visible and bigger ones is the three series for new manufacturing orders. The leading index includes two dollar-based new orders series and one diffusion measure. A diffusion measure captures the breath of change, not the magnitude of change. In other words, it does not distinguish between the size of the gain or decline. Yet, dollar-based series are more important in determining economic growth since the economy runs on dollars spent.

In May, the leading index fell 0.7%. The ISM new orders index posted the most significant decline (1.4%) of any indicator, overwhelming the small gain in the other two order series (0.1% and 0.2%, respectively).

Today, the Census Bureau reported that new orders for durable goods, a dollar-based series, rose 1.8% in May. And excluding the volatile transportation sector, new orders rose 0.6%. The latest data will result in an upward revision to the dollar-based series in the leading index, but not enough to wipe out the negative contribution of the ISM New orders index.

How can anyone trust the signal from the index of leading indicators when the dollar-based new orders for durable manufactured goods (excluding transportation) posted in May, their most significant gain in over a year, and yet the sum of the three orders series in the leading index is negative because of a sharp decline in diffusion-based series? The economy runs on dollars.

The year-over-year change in the All-Items CPI for May 2023 was 4.13%. My forecast is that the year-over-year change in the All-Items CPI for June 2023 will be less than 4.13%. Barring revisions, the seasonally-adjusted month-to-month percent change in the June CPI would have to be 1.19% non annualized for the year-over-year change in the June All-Items CPI to be equal to May’s 4.13%. Coincidentally (I think), the last time the month-to-month non-annualized change in the CPI was as high as 1.19% was June 2022, when it was exactly 1.19%. If the June 2023 All-Items CPI increases by 0.55% (non-annualized), the average non-annualized percent change in the CPI in the three months ended May 2023, the June 2023 year-over-year change in the CPI would slow to 3.47% vs. May’s 4.13%.

This is not economics. Rather, it is arithmetic. And it is all about that June 2022 base. (It took me a while, but I got there.) Plotted in Chart 1 are the month-to-month annualized percent changes in the All-Items CPI (the blue bars) along with the monthly observations of the year-over-year percent changes in the All-Items CPI (the red line). The June 2022 CPI increased a whopping annualized 15.22%. The June 2022 level of the CPI is the base for the June 2023 year-over-year percent change observation. With such a high June 2022 base, the bias is for a slowing in the year-over-year percent change in June 2023. The year-over-year percent changes in the All-Items CPI beyond June 2023 are not likely to slow as much because the high June 2022 base will drop out of the calculation. However, in the 11 months ended May 2023, the All-Items CPI has increased an annualized 3.17%. So, barring some negative supply shock in the remainder of 2023, the year-over-year change in the December 2023 All-Items CPI is likely to be much lower than the 6.44% for December 2022. For example if the CPI increases a non-annualized 0.3% from June through December 2023, the December 2023 year-over-year change in the All-Items CPI would be 3.59%. I believe that the monthly non-annualized changes in the All-Items CPI will, on average, be less than 0.3%. Thus, I believe that the year-over-year change in CPI as of December 2023 will be less than 3.59%.

The Federal Reserve Bank of Philadelphia’s state coincident indexes in May increased in from April in all but 3 states (Rhode Island, Minnesota, and Kentucky). Vermont and Massachusetts were again the leaders, and the only states with increases above 1 percent, but unlike in April Massachusetts took the top spot. These two were also the states with the largest 3-month increases (Massachusetts was up by close to 4 percent). However, a full 23 states had increases over this horizon of less than 1 percent (Rhode Island’s was barely positive). Over the past 12 months, Massachusetts was yet again the leader, with an increase of over 6 percent, perhaps some consolation for the Celtics’ fadeout in the NBA playoffs. Texas was a fairly distant second. Kansas and Missouri had increases of less than 1 percent.

The independently estimated national figures of growth over the last 3 months (.78 percent) looks roughly in line, though perhaps a bit short, of what the state figures suggest, while the corresponding 12-month result (3.65 percent) looks like it might be somewhat stronger than the state numbers.